I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
|Levered FCF ($, Millions)||$97.00||$104.00||$107.88||$111.91||$116.09|
|Source||Analyst x1||Analyst x1||Extrapolated @ (3.73%)||Extrapolated @ (3.73%)||Extrapolated @ (3.73%)|
|Present Value Discounted @ 8.59%||$89.33||$88.20||$84.25||$80.49||$76.89|
Present Value of 5-year Cash Flow (PVCF)= $419.15
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 8.6%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $116.09 × (1 + 2.9%) ÷ (8.6% – 2.9%) = $2.12k
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $2.12k / ( 1 + 8.6%)5 = $1.40k
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $1.82k. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $45.2. Compared to the current share price of $46.4, the stock is fair value, maybe slightly overvalued at the time of writing.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Phibro Animal Health as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.6%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For PAHC, I’ve compiled three relevant aspects you should look at:
- Financial Health: Does PAHC have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does PAHC’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of PAHC? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.