U.S. Markets closed

An Intrinsic Calculation For Patrick Industries Inc (NASDAQ:PATK) Shows It’s 49.26% Undervalued

I am going to run you through how I calculated the intrinsic value of Patrick Industries Inc (NASDAQ:PATK) by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Patrick Industries by following the link below.

View our latest analysis for Patrick Industries

Crunching the numbers

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

2019 2020 2021 2022 2023
Levered FCF ($, Millions) $156.36 $186.07 $219.57 $256.89 $298.00
Source Analyst x4 Est @ 19%, capped from 26.32% Est @ 18%, capped from 26.32% Est @ 17%, capped from 26.32% Est @ 16%, capped from 26.32%
Present Value Discounted @ 14.22% $136.90 $142.63 $147.35 $150.93 $153.28

Present Value of 5-year Cash Flow (PVCF)= US$731m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 14.2%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$298m × (1 + 2.9%) ÷ (14.2% – 2.9%) = US$2.7b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$2.7b ÷ ( 1 + 14.2%)5 = US$1.4b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$2.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $86.88. Compared to the current share price of $44.08, the stock is quite undervalued at a 49% discount to what it is available for right now.

NasdaqGS:PATK Intrinsic Value Export October 26th 18

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Patrick Industries as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 14.2%, which is based on a levered beta of 1.599. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

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. What is the reason for the share price to differ from the intrinsic value? For PATK, there are three essential factors you should further research:

  1. Financial Health: Does PATK have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does PATK’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.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PATK? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.