Calculation of the intrinsic value of Heska Corporation (NASDAQ: HSKA)
In this article, we’ll estimate the intrinsic value of Heska Corporation (NASDAQ: HSKA) by taking expected future cash flows and discounting them to present value. This will be done using the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are easy enough to follow.
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Check out our latest analysis for Heska
The calculation
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for 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 the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of those future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | -6.06 million USD | $ 15.5 million | $ 35.0 million | $ 52.6 million | $ 71.4 million | 89.7 million USD | 106.4 million USD | $ 120.8 million | $ 133.0 million | 143.2 million USD |
Source of estimated growth rate | Analyst x2 | Analyst x2 | Analyst x1 | Is 50.26% | Is at 35.78% | Is 25.64% | Is 18.55% | Is 13.58% | Is 10.1% | Is 7.67% |
Present value ($, millions) discounted at 6.2% | -5.7 USD | $ 13.8 | $ 29.2 | $ 41.4 | $ 52.9 | $ 62.6 | $ 69.8 | US $ 74.7 | US $ 77.4 | US $ 78.5 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 494 million USD
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. 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 6.2%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 143 million × (1 + 2.0%) ÷ (6.2% – 2.0%) = $ 3.5 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= USD 3.5 billion ÷ (1 + 6.2%)^{ten}= 1.9 billion USD
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 2.4 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 200, the company appears to have fair value at a 13% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The hypotheses
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. 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 complete picture of a company’s potential performance. Since we view Heska 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 debt into account. In this calculation, we used 6.2%, which is based on a leveraged beta of 0.890. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Looking forward:
While important, the DCF calculation is just one of the many factors you need to assess for a business. The DCF model is not a perfect inventory valuation tool. Rather, it should be seen as a guide to “what assumptions must 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 have a significant impact on valuation. For Heska, you need to evaluate three other things:
- Risks: Concrete example, we have spotted 1 warning sign for Heska you have to be aware of it.
- Future income: How does HSKA’s growth rate compare to its peers and to the overall market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQCM 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. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
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