A Look At The Intrinsic Value Of Herbalife Ltd. (NYSE:HLF)

Key Insights

• The projected fair value for Herbalife is US$9.20 based on 2 Stage Free Cash Flow to Equity
• Herbalife's US$10.83 share price indicates it is trading at similar levels as its fair value estimate
• Our fair value estimate is 6.2% higher than Herbalife's analyst price target of US$8.67

Today we will run through one way of estimating the intrinsic value of Herbalife Ltd. (NYSE:HLF) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.

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. To begin with, we have to get estimates of the next ten years of cash flows. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF ($, Millions)	US$118.0m	US$104.0m	US$96.3m	US$92.1m	US$90.2m	US$89.6m	US$90.0m	US$91.1m	US$92.7m	US$94.6m
Growth Rate Estimate Source	Est @ -18.19%	Est @ -11.85%	Est @ -7.42%	Est @ -4.31%	Est @ -2.13%	Est @ -0.61%	Est @ 0.45%	Est @ 1.20%	Est @ 1.72%	Est @ 2.09%
Present Value ($, Millions) Discounted @ 12%	US$106	US$83.5	US$69.3	US$59.4	US$52.1	US$46.4	US$41.7	US$37.9	US$34.5	US$31.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$562m

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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = US$95m× (1 + 2.9%) ÷ (12%– 2.9%) = US$1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.1b÷ ( 1 + 12%)¹⁰= US$375m

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$937m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$10.8, the company appears around fair value at the time of writing. 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 Herbalife 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 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.

See our latest analysis for Herbalife

SWOT Analysis for Herbalife

Looking Ahead:

Although the valuation of a company is important, it 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Herbalife, there are three pertinent factors you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Herbalife (at least 3 which are a bit unpleasant) , and understanding them should be part of your investment process.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for HLF'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.