Are Investors Undervaluing RadNet, Inc. (NASDAQ:RDNT) By 42%?
Key Insights
RadNet's estimated fair value is US$48.52 based on 2 Stage Free Cash Flow to Equity
Current share price of US$28.37 suggests RadNet is potentially 42% undervalued
The US$34.50 analyst price target for RDNT is 29% less than our estimate of fair value
Does the May share price for RadNet, Inc. (NASDAQ:RDNT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for RadNet
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$50.0m | US$82.5m | US$117.5m | US$144.8m | US$169.3m | US$190.4m | US$208.2m | US$223.2m | US$235.8m | US$246.6m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x1 | Est @ 23.23% | Est @ 16.90% | Est @ 12.46% | Est @ 9.35% | Est @ 7.18% | Est @ 5.66% | Est @ 4.59% |
Present Value ($, Millions) Discounted @ 8.3% | US$46.1 | US$70.3 | US$92.5 | US$105 | US$114 | US$118 | US$119 | US$118 | US$115 | US$111 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.0b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$247m× (1 + 2.1%) ÷ (8.3%– 2.1%) = US$4.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.1b÷ ( 1 + 8.3%)10= US$1.8b
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$2.8b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$28.4, the company appears quite good value at a 42% 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 RadNet 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 8.3%, which is based on a levered beta of 1.046. 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 RadNet
Strength
Debt is well covered by cash flow.
Weakness
Interest payments on debt are not well covered.
Shareholders have been diluted in the past year.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Trading below our estimate of fair value by more than 20%.
Threat
No apparent threats visible for RDNT.
Looking Ahead:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For RadNet, there are three additional factors you should assess:
Risks: We feel that you should assess the 3 warning signs for RadNet (1 is potentially serious!) we've flagged before making an investment in the company.
Future Earnings: How does RDNT'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.
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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