Intrinsic math for Henry Schein, Inc. (NASDAQ: HSIC) suggests he’s 35% undervalued
Today we’re going to review one way to estimate the intrinsic value of Henry Schein, Inc. (NASDAQ: HSIC) by projecting its future cash flows, then discounting them 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.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
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Is Henry Schein valued enough?
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 estimate the next ten years of cash flow. 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 need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
|Leverage FCF ($, Millions)||US $ 663.0 million||US $ 743.6 million||US $ 837.7 million||US $ 773.0 million||US $ 751.0 million||US $ 752.6 million||US $ 758.2 million||US $ 766.7 million||US $ 777.3 million||US $ 789.4 million|
|Source of estimated growth rate||Analyst x4||Analyst x4||Analyst x2||Analyst x1||Analyst x1||East @ 0.21%||Is 0.75%||Est @ 1.12%||Est @ 1.38%||Is @ 1.56%|
|Present value (in millions of dollars) discounted at 6.0%||US $ 625||US $ 662||US $ 703||US $ 612||US $ 561||US $ 531||US $ 504||US $ 481||US $ 460||$ 441|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 5.6 billion US dollars
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this 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 6.0%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 789 million × (1 + 2.0%) ÷ (6.0% – 2.0%) = US $ 20 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 20 billion ÷ (1 + 6.0%)ten= US $ 11 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 $ 17 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 77.9, the company looks fairly good value at a 35% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 consider Henry Schein 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 6.0%, which is based on a leveraged beta of 0.849. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For Henry Schein, we have compiled three relevant aspects that you should take a closer look at:
- Risks: Know that Henry Schein shows 2 warning signs in our investment analysis , you must know…
- Future benefits: How does HSIC’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGS 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 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 the mentioned stocks.
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