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Are Denny's Corporation (NASDAQ:DENN) Investors Paying Above The Intrinsic Value?

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Denny's fair value estimate is US$8.83

  • Denny's is estimated to be 24% overvalued based on current share price of US$10.99

  • Analyst price target for DENN is US$14.42, which is 63% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Denny's Corporation (NASDAQ:DENN) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Denny's

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years 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 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) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$79.2m

US$60.8m

US$50.9m

US$45.4m

US$42.2m

US$40.4m

US$39.5m

US$39.1m

US$39.0m

US$39.3m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ -16.31%

Est @ -10.80%

Est @ -6.94%

Est @ -4.24%

Est @ -2.34%

Est @ -1.02%

Est @ -0.09%

Est @ 0.56%

Present Value ($, Millions) Discounted @ 10%

US$71.9

US$50.1

US$38.1

US$30.8

US$26.1

US$22.7

US$20.1

US$18.1

US$16.4

US$15.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$309m

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 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$39m× (1 + 2.1%) ÷ (10%– 2.1%) = US$497m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$497m÷ ( 1 + 10%)10= US$189m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$498m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$11.0, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important 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 Denny's 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 1.358. 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 Denny's

Strength

  • Debt is well covered by earnings.

Weakness

  • Earnings declined over the past year.

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

  • DENN's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

  • Debt is not well covered by operating cash flow.

  • Total liabilities exceed total assets, which raises the risk of financial distress.

  • Annual earnings are forecast to decline for the next 2 years.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. Can we work out why the company is trading at a premium to intrinsic value? For Denny's, there are three fundamental factors you should look at:

  1. Risks: Case in point, we've spotted 5 warning signs for Denny's you should be aware of, and 3 of them are significant.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DENN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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