Afya Limited (NASDAQ:AFYA) shares could be 43% below their estimated intrinsic value

Key findings

• The projected fair value for Afya is $30.02 based on 2-step free cash flow to equity
• Afya’s share price of $17.24 suggests the company could be undervalued by 43%
• Our fair value estimate is 32% above Afya’s analyst price target of R$22.78.

Does Afya Limited’s (NASDAQ:AFYA) share price in June reflect its true value? Today we will estimate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will use for this. This may sound complicated, but it’s actually quite simple!

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. For those who enjoy stock analysis, the analysis model from Simply Wall St listed here might be of interest.

Check out our latest analysis for Afya

The calculation

We use a two-stage DCF model which, as the name suggests, considers two phases of growth. The first stage is generally a higher growth phase that stabilizes toward the terminal value captured in the second “steady growth” stage. First, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren’t available, we extrapolate previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

A DCF is all about 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:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = R$7.6 billion

We now need to calculate the terminal value that 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 Treasury yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 11%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = R$1.6 billion × (1 + 2.4%) ÷ (11% – 2.4%) = R$19 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= R$19 billion ÷ (1 + 11%)¹⁰= R$6.9 billion

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is R$14 billion. The last step is to divide the equity value by the number of shares outstanding. Relative to the current share price of $17.2, the company seems quite undervalued at a 43% discount to the current share price. However, keep in mind that this is only an approximate valuation and, as with any complex formula, where there’s garbage in, there’s garbage out.

The assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider Afya 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 11%, which is based on a leveraged beta of 0.953. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Afya

Next Steps:

While the DCF calculation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. Why is the intrinsic value higher than the current share price? For Afya, we have compiled three key aspects that you should examine in more detail:

1. Financial health: Does AFYA have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.
2. Future income: How does AFYA’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment based solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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