Estimating The Fair Value Of DLH Holdings Corp. (NASDAQ:DLHC)
Key Insights
The projected fair value for DLH Holdings is US$17.70 based on 2 Stage Free Cash Flow to Equity
Current share price of US$14.32 suggests DLH Holdings is potentially trading close to its fair value
DLH Holdings' peers are currently trading at a premium of 1,922% on average
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of DLH Holdings Corp. (NASDAQ:DLHC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for DLH Holdings
Crunching The Numbers
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$24.4m | US$21.2m | US$19.4m | US$18.4m | US$17.8m | US$17.5m | US$17.5m | US$17.6m | US$17.7m | US$18.0m |
Growth Rate Estimate Source | Est @ -19.75% | Est @ -13.16% | Est @ -8.55% | Est @ -5.32% | Est @ -3.06% | Est @ -1.47% | Est @ -0.37% | Est @ 0.41% | Est @ 0.95% | Est @ 1.33% |
Present Value ($, Millions) Discounted @ 8.7% | US$22.5 | US$18.0 | US$15.1 | US$13.2 | US$11.7 | US$10.6 | US$9.7 | US$9.0 | US$8.4 | US$7.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$126m
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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$18m× (1 + 2.2%) ÷ (8.7%– 2.2%) = US$283m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$283m÷ ( 1 + 8.7%)10= US$123m
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$249m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$14.3, the company appears about fair value at a 19% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 DLH 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 8.7%, which is based on a levered beta of 1.296. 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 DLH Holdings
Strength
No major strengths identified for DLHC.
Weakness
Earnings declined over the past year.
Interest payments on debt are not well covered.
Shareholders have been diluted in the past year.
Opportunity
Current share price is below our estimate of fair value.
Threat
Debt is not well covered by operating cash flow.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. For DLH Holdings, there are three important elements you should consider:
Risks: Every company has them, and we've spotted 4 warning signs for DLH Holdings (of which 1 can't be ignored!) you should know about.
Future Earnings: How does DLHC'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
