Stock Analysis

An Intrinsic Calculation For Cardinal Health, Inc. (NYSE:CAH) Suggests It's 45% Undervalued

NYSE:CAH
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Key Insights

  • The projected fair value for Cardinal Health is US$171 based on 2 Stage Free Cash Flow to Equity
  • Cardinal Health is estimated to be 45% undervalued based on current share price of US$93.42
  • Our fair value estimate is 88% higher than Cardinal Health's analyst price target of US$90.81

How far off is Cardinal Health, Inc. (NYSE:CAH) 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 forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Cardinal Health

The Model

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 begin with, we have to get estimates of 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$2.09b US$1.92b US$1.74b US$2.26b US$2.30b US$2.34b US$2.38b US$2.43b US$2.48b US$2.53b
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x2 Analyst x2 Est @ 1.73% Est @ 1.85% Est @ 1.93% Est @ 1.98% Est @ 2.02% Est @ 2.05%
Present Value ($, Millions) Discounted @ 6.9% US$2.0k US$1.7k US$1.4k US$1.7k US$1.6k US$1.6k US$1.5k US$1.4k US$1.4k US$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$16b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.1%) 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 6.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.5b× (1 + 2.1%) ÷ (6.9%– 2.1%) = US$54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$54b÷ ( 1 + 6.9%)10= US$28b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$44b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$93.4, the company appears quite undervalued at a 45% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:CAH Discounted Cash Flow July 14th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Cardinal Health 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 6.9%, which is based on a levered beta of 0.801. 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.

SWOT Analysis for Cardinal Health

Strength
  • Debt is well covered by earnings and cashflows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Healthcare market.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Dividends are not covered by earnings.
  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Cardinal Health, we've put together three additional aspects you should explore:

  1. Risks: Every company has them, and we've spotted 4 warning signs for Cardinal Health you should know about.
  2. Future Earnings: How does CAH's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  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.

Valuation is complex, but we're helping make it simple.

Find out whether Cardinal Health is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.