Are Investors Undervaluing ATI Physical Therapy, Inc. (NYSE:ATIP) By 23%?
Key Insights
Using the 2 Stage Free Cash Flow to Equity, ATI Physical Therapy fair value estimate is US$10.46
Current share price of US$8.09 suggests ATI Physical Therapy is potentially 23% undervalued
When compared to theindustry average discount to fair value of 39%, ATI Physical Therapy's competitors seem to be trading at a greater discount
Today we will run through one way of estimating the intrinsic value of ATI Physical Therapy, Inc. (NYSE:ATIP) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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. 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 ATI Physical Therapy
The Model
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. 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.
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$18.1m | US$519.0k | US$1.19m | US$2.28m | US$3.75m | US$5.47m | US$7.27m | US$8.99m | US$10.5m | US$11.9m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Est @ 129.54% | Est @ 91.35% | Est @ 64.61% | Est @ 45.89% | Est @ 32.79% | Est @ 23.62% | Est @ 17.20% | Est @ 12.71% |
Present Value ($, Millions) Discounted @ 12% | -US$16.1 | US$0.4 | US$0.8 | US$1.4 | US$2.1 | US$2.7 | US$3.2 | US$3.6 | US$3.7 | US$3.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$5.7m
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 12%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$12m× (1 + 2.2%) ÷ (12%– 2.2%) = US$121m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$121m÷ ( 1 + 12%)10= US$38m
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$44m. 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$8.1, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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 ATI Physical Therapy 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 12%, which is based on a levered beta of 2.000. 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 ATI Physical Therapy
Strength
Debt is well covered by earnings.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Good value based on P/S ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Has less than 3 years of cash runway based on current free cash flow.
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. 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. Why is the intrinsic value higher than the current share price? For ATI Physical Therapy, we've compiled three essential aspects you should assess:
Risks: Take risks, for example - ATI Physical Therapy has 5 warning signs (and 1 which shouldn't be ignored) we think you should know about.
Future Earnings: How does ATIP'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.
