- United States
- Healthcare Services
Are Investors Undervaluing HCA Healthcare, Inc. (NYSE:HCA) By 45%?
- Using the 2 Stage Free Cash Flow to Equity, HCA Healthcare fair value estimate is US$451
- HCA Healthcare's US$247 share price signals that it might be 45% undervalued
- Analyst price target for HCA is US$281 which is 38% below our fair value estimate
Does the March share price for HCA Healthcare, Inc. (NYSE:HCA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for HCA Healthcare
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$4.56b||US$4.94b||US$6.36b||US$6.49b||US$7.14b||US$7.62b||US$8.04b||US$8.39b||US$8.70b||US$8.98b|
|Growth Rate Estimate Source||Analyst x5||Analyst x5||Analyst x3||Analyst x2||Analyst x2||Est @ 6.80%||Est @ 5.38%||Est @ 4.39%||Est @ 3.69%||Est @ 3.21%|
|Present Value ($, Millions) Discounted @ 7.6%||US$4.2k||US$4.3k||US$5.1k||US$4.8k||US$4.9k||US$4.9k||US$4.8k||US$4.7k||US$4.5k||US$4.3k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$46b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.1%) 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 7.6%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$9.0b× (1 + 2.1%) ÷ (7.6%– 2.1%) = US$164b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$164b÷ ( 1 + 7.6%)10= US$79b
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$125b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$247, the company appears quite good value at a 45% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
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 HCA Healthcare 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 7.6%, which is based on a levered beta of 0.939. 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 HCA Healthcare
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Healthcare market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Total liabilities exceed total assets, which raises the risk of financial distress.
- Annual earnings are forecast to grow slower than the American market.
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For HCA Healthcare, we've compiled three further factors you should look at:
- Risks: We feel that you should assess the 3 warning signs for HCA Healthcare (1 is significant!) we've flagged before making an investment in the company.
- Future Earnings: How does HCA'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.
- 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 HCA Healthcare 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.View the Free Analysis
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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.
HCA Healthcare, Inc., through its subsidiaries, provides health care services in the United States.
Undervalued with limited growth.