A Look At The Fair Value Of Regional Health Properties, Inc. (NYSEMKT:RHE)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Regional Health Properties, Inc. (NYSEMKT:RHE) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Regional Health Properties

The calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF ($, Millions)	US$1.74m	US$1.64m	US$1.59m	US$1.56m	US$1.55m	US$1.55m	US$1.57m	US$1.58m	US$1.61m	US$1.63m
Growth Rate Estimate Source	Est @ -9.04%	Est @ -5.72%	Est @ -3.39%	Est @ -1.76%	Est @ -0.62%	Est @ 0.18%	Est @ 0.74%	Est @ 1.13%	Est @ 1.4%	Est @ 1.59%
Present Value ($, Millions) Discounted @ 13%	US$1.6	US$1.3	US$1.1	US$1.0	US$0.9	US$0.8	US$0.7	US$0.6	US$0.6	US$0.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.0m

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 (2.0%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = US$1.6m× (1 + 2.0%) ÷ (13%– 2.0%) = US$16m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$16m÷ ( 1 + 13%)¹⁰= US$4.9m

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$13m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$7.1, the company appears about fair value at a 8.1% 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

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 Regional Health Properties 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 13%, which is based on a levered beta of 2.000. 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Regional Health Properties, we've put together three important elements you should look at:

1. Risks: Case in point, we've spotted 2 warning signs for Regional Health Properties you should be aware of.
2. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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. 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.
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