An intrinsic calculation for HCA Healthcare, Inc. (NYSE: HCA) suggests it’s 43% undervalued
How far is HCA Healthcare, Inc. (NYSE: HCA) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking the company’s future cash flow forecast and discounting it to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don’t be put off by the lingo, the math is actually pretty straightforward.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Check out our latest review for HCA Healthcare
Crunch the numbers
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | US $ 5.08 billion | US $ 5.35 billion | US $ 6.20b | US $ 6.58b | US $ 6.88b | 7.14 billion US dollars | 7.37 billion US dollars | 7.58 billion US dollars | 7.77 billion US dollars | US $ 7.96b |
Source of estimated growth rate | Analyst x6 | Analyst x4 | Analyst x2 | Analyst x1 | East @ 4.5% | East @ 3.75% | East @ 3.22% | East @ 2.85% | Is @ 2.59% | East @ 2.41% |
Present value (in millions of dollars) discounted at 6.5% | US $ 4.8K | 4.7,000 USD | US $ 5.1k | US $ 5.1k | US $ 5.0k | US $ 4.9k | US $ 4.7k | US $ 4.6K | 4.4,000 USD | US $ 4.2k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 48 billion US dollars
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.5%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 8.0B × (1 + 2.0%) ÷ (6.5% – 2.0%) = US $ 179B
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 179 billion ÷ (1 + 6.5%)^{ten}= US $ 95 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 142 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US $ 256, the company appears to be quite undervalued with a 43% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view 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 takes into account debt. In this calculation, we used 6.5%, which is based on a leveraged beta of 0.963. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
To move on :
While valuing a business is important, it’s just one of the many factors you need to assess for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Why is intrinsic value greater than the current share price? For HCA Healthcare, we’ve compiled three important aspects that you should research further:
- Risks: Note that HCA Healthcare displays 2 warning signs in our investment analysis , and 1 of them is a bit disturbing …
- Management: Have insiders increased their stocks to take advantage of market sentiment about HCA’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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