Calculating The Intrinsic Value Of El Pollo Loco Holdings, Inc. (NASDAQ:LOCO)
Key Insights
The projected fair value for El Pollo Loco Holdings is US$11.05 based on 2 Stage Free Cash Flow to Equity
El Pollo Loco Holdings' US$10.39 share price indicates it is trading at similar levels as its fair value estimate
The US$11.33 analyst price target for LOCO is 2.5% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for El Pollo Loco Holdings
What's The Estimated Valuation?
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$30.4m | US$32.2m | US$33.8m | US$35.2m | US$36.4m | US$37.5m | US$38.6m | US$39.6m | US$40.5m | US$41.5m |
Growth Rate Estimate Source | Est @ 7.78% | Est @ 6.08% | Est @ 4.89% | Est @ 4.05% | Est @ 3.47% | Est @ 3.06% | Est @ 2.78% | Est @ 2.58% | Est @ 2.44% | Est @ 2.34% |
Present Value ($, Millions) Discounted @ 11% | US$27.5 | US$26.4 | US$25.0 | US$23.6 | US$22.1 | US$20.6 | US$19.1 | US$17.7 | US$16.4 | US$15.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$214m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 11%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$41m× (1 + 2.1%) ÷ (11%– 2.1%) = US$502m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$502m÷ ( 1 + 11%)10= US$184m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$398m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$10.4, the company appears about fair value at a 6.0% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at El Pollo Loco Holdings 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 accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 1.419. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for El Pollo Loco Holdings
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Current share price is below our estimate of fair value.
Threat
Debt is not well covered by operating cash flow.
Annual revenue is forecast to grow slower than the American market.
Next Steps:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For El Pollo Loco Holdings, we've compiled three further items you should consider:
Risks: Be aware that El Pollo Loco Holdings is showing 1 warning sign in our investment analysis , you should know about...
Future Earnings: How does LOCO's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
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 is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
