HCA Healthcare, Inc.'s (NYSE:HCA) Intrinsic Value Is Potentially 45% Above Its Share Price

Key Insights

• HCA Healthcare's estimated fair value is US$427 based on 2 Stage Free Cash Flow to Equity
• HCA Healthcare's US$295 share price signals that it might be 31% undervalued
• The US$313 analyst price target for HCA is 27% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of HCA Healthcare, Inc. (NYSE:HCA) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for HCA Healthcare

Step By Step Through The Calculation

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$4.50b	US$4.71b	US$6.36b	US$6.36b	US$6.76b	US$7.06b	US$7.33b	US$7.58b	US$7.80b	US$8.01b
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x3	Analyst x1	Analyst x1	Est @ 4.53%	Est @ 3.81%	Est @ 3.30%	Est @ 2.94%	Est @ 2.69%
Present Value ($, Millions) Discounted @ 7.5%	US$4.2k	US$4.1k	US$5.1k	US$4.8k	US$4.7k	US$4.6k	US$4.4k	US$4.2k	US$4.1k	US$3.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$44b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$8.0b× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$152b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$152b÷ ( 1 + 7.5%)¹⁰= US$74b

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$118b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$295, the company appears quite undervalued at a 31% 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

We would point out that 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 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 7.5%, which is based on a levered beta of 0.908. 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

Looking Ahead:

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. 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. Why is the intrinsic value higher than the current share price? For HCA Healthcare, there are three additional items you should assess:

1. Risks: We feel that you should assess the 2 warning signs for HCA Healthcare we've flagged before making an investment in the company.
2. 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.
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.