Is there an opportunity with the 22% undervaluation of Churchill Downs Incorporated (NASDAQ: CHDN)?
Does the July share price for Churchill Downs Incorporated (NASDAQ: CHDN) reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. 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.
The calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. 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 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 $ 323.2 million | $ 403.6 million | US $ 476.4 million | US $ 539.3 million | $ 592.4 million | US $ 636.8 million | US $ 674.0 million | US $ 705.6 million | US $ 732.9 million | US $ 757.2 million |
Source of growth rate estimate | Analyst x3 | Is 24.9% | Est @ 18.03% | East @ 13.22% | Est @ 9.85% | Est @ 7.49% | Est @ 5.84% | East @ 4.69% | Est @ 3.88% | East @ 3.31% |
Present value (in millions of dollars) discounted at 8.2% | US $ 299 | US $ 345 | US $ 376 | US $ 393 | US $ 399 | US $ 396 | $ 387 | US $ 375 | 360 USD | US $ 343 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 3.7 billion
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 8.2%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 757 million × (1 + 2.0%) ÷ (8.2% to 2.0%) = US $ 12 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 12 billion ÷ (1 + 8.2%)^{ten}= 5.6 billion US dollars
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 $ 9.3 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current price of US $ 192, the company appears to be slightly undervalued with a 22% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NasdaqGS: CHDN Discounted Cash Flow July 11, 2021
The hypotheses
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. 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 Churchill Downs 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 8.2%, which is based on a leveraged beta of 1.322. 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. DCF models are not the alpha and omega of investment valuation. 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. Why is intrinsic value greater than the current share price? For Churchill Downs, we have put together three fundamental aspects to consider:
- Risks: Know that Churchill Downs shows 1 warning sign in our investment analysis , you must know…
- Future benefits: How does CHDN’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number 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, do a search here.
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 any of the stocks mentioned.
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