Estimating The Fair Value Of Brookdale Senior Living Inc. (NYSE:BKD)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Brookdale Senior Living fair value estimate is US$6.17
• With US$6.03 share price, Brookdale Senior Living appears to be trading close to its estimated fair value
• Industry average discount to fair value of 17% suggests Brookdale Senior Living's peers are currently trading at a higher discount

How far off is Brookdale Senior Living Inc. (NYSE:BKD) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Brookdale Senior Living

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$23.5m	US$46.9m	US$67.4m	US$88.4m	US$108.4m	US$126.1m	US$141.5m	US$154.5m	US$165.4m	US$174.8m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 43.63%	Est @ 31.21%	Est @ 22.51%	Est @ 16.42%	Est @ 12.16%	Est @ 9.18%	Est @ 7.09%	Est @ 5.63%
Present Value ($, Millions) Discounted @ 12%	US$21.0	US$37.6	US$48.4	US$56.8	US$62.3	US$64.9	US$65.2	US$63.7	US$61.1	US$57.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$539m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$175m× (1 + 2.2%) ÷ (12%– 2.2%) = US$1.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.9b÷ ( 1 + 12%)¹⁰= US$623m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$6.0, the company appears about fair value at a 2.3% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Brookdale Senior Living as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 12%, which is based on a levered beta of 1.897. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Brookdale Senior Living, we've put together three important aspects you should explore:

1. Risks: For example, we've discovered 1 warning sign for Brookdale Senior Living that you should be aware of before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BKD's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.