Is there an opportunity with the 50% undervaluation of Universal Health Services, Inc. (NYSE: UHS)?
In this article, we’ll estimate the intrinsic value of Universal Health Services, Inc. (NYSE: UHS) by estimating the company’s future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Our analysis indicates that UHS is potentially undervalued!
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later 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 these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||$418.0 million||$559.0 million||$666.0 million||$759.2 million||$838.1 million||$904.0 million||$959.2 million||US$1.01 billion||$1.05 billion||$1.08 billion|
|Growth rate estimate Source||Analyst x1||Analyst x1||East @ 19.14%||Is at 13.99%||Is at 10.39%||Is at 7.87%||Is at 6.1%||Is at 4.86%||Is @ 4%||Is @ 3.39%|
|Present value (millions of dollars) discounted at 7.2%||$390||$486||$540||$574||$591||US$595||$588||$575||$558||$538|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $5.4 billion
We now need to calculate the terminal value, which represents 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 10-year government bond yield of 2.0%. We discount terminal cash flows to present value at a cost of equity of 7.2%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = $1.1 billion × (1 + 2.0%) ÷ (7.2%–2.0%) = $21 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $21 billion ÷ (1 + 7.2%)ten= $10 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $16 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$112, the company looks quite undervalued at a 50% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Universal Health Services 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 7.2%, which is based on a leveraged beta of 1.024. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT analysis for universal health services
- Debt is well covered by earnings and cash flow.
- Revenues have declined over the past year.
- The dividend is low compared to the top 25% of dividend payers in the healthcare market.
- Annual revenues are expected to increase over the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are expected to grow more slowly than the US market.
Let’s move on :
Although a business valuation is important, it is only one of many factors you need to assess for a business. DCF models are not the be-all and end-all 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Can we understand why the company is trading at a discount to its intrinsic value? For universal health services, there are three essential elements to consider:
- Risks: For example, we found 2 warning signs for universal health services that you must consider before investing here.
- Future earnings: How does UHS’ growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
Valuation is complex, but we help make it simple.
Find out if Universal health services is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.