Is there an opportunity given AdaptHealth Corp.’s (NASDAQ:AHCO) 37% undervaluation?

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of AdaptHealth is $16.89
• The current share price of $10.61 suggests that AdaptHealth may be undervalued by 37%
• The analyst price target of $11.95 for AHCO is 29% below our fair value estimate

Does AdaptHealth Corp. (NASDAQ:AHCO)’s July share price reflect its actual value? Today, we’ll estimate the stock’s intrinsic value by taking the company’s projected future cash flows and discounting them to today’s value. This is done using the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they’re relatively easy to follow.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. If you want to learn more about intrinsic value, you should check out Simply Wall St’s analysis model.

Check out our latest analysis for AdaptHealth

The method

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to estimate the next ten years’ worth of cash flows. Where possible, we use analyst estimates, but when these aren’t available, we extrapolate the 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.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 950 million US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. 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 8.0%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = 147 million US dollars × (1 + 2.4%) ÷ (8.0% – 2.4%) = 2.7 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 2.7 billion US dollars ÷ (1 + 8.0%)¹⁰= 1.2 billion US dollars

The total value or equity value is then the sum of the present value of future cash flows, which in this case is $2.2 billion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $10.6, the company appears significantly undervalued at a 37% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it is better to consider this as a rough estimate that is not accurate to the last cent.

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 AdaptHealth 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 8.0%, which is based on a leveraged beta of 1.228. 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 AdaptHealth

Go on:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. DCF models are not the be-all and end-all of investment valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. For example, adjusting the terminal value growth rate slightly can change the overall result dramatically. Why is the intrinsic value higher than the current share price? For AdaptHealth, we have compiled three other points you should examine in more detail:

1. Financial health: Does AHCO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as leverage and risk.
2. Future income: How does AHCO’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 high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of ​​what else you might be missing out on!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the NASDAQCM every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of 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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