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$10.75 based on 2 Stage Free Cash Flow to Equity
El Pollo Loco Holdings' US$8.61 share price indicates it is trading at similar levels as its fair value estimate
The US$10.50 analyst price target for LOCO is 2.4% less than our estimate of fair value
In this article we are going to estimate the intrinsic value of El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for El Pollo Loco Holdings
The Method
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$30.4m | US$30.4m | US$30.7m | US$31.1m | US$31.5m | US$32.1m | US$32.7m | US$33.3m | US$34.0m | US$34.7m |
Growth Rate Estimate Source | Est @ -0.74% | Est @ 0.15% | Est @ 0.77% | Est @ 1.21% | Est @ 1.51% | Est @ 1.72% | Est @ 1.87% | Est @ 1.98% | Est @ 2.05% | Est @ 2.10% |
Present Value ($, Millions) Discounted @ 10% | US$27.5 | US$25.0 | US$22.8 | US$20.9 | US$19.3 | US$17.7 | US$16.4 | US$15.1 | US$14.0 | US$12.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$192m
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 (2.2%) 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 10%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$35m× (1 + 2.2%) ÷ (10%– 2.2%) = US$436m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$436m÷ ( 1 + 10%)10= US$163m
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$354m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$8.6, the company appears about fair value at a 20% 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 10%, which is based on a levered beta of 1.628. 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
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Weakness
No major weaknesses identified for LOCO.
Opportunity
Current share price is below our estimate of fair value.
Threat
Annual earnings are forecast to decline for the next 3 years.
Looking Ahead:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 put together three relevant elements you should further research:
Risks: Every company has them, and we've spotted 1 warning sign for El Pollo Loco Holdings 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.
