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A Look At The Fair Value Of Aramark (NYSE:ARMK)

In this article I am going to calculate the intrinsic value of Aramark (NYSE:ARMK) by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.

The calculation

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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

 2019 2020 2021 2022 2023 Levered FCF (\$, Millions) \$574.93 \$581.75 \$911.00 \$1.01k \$1.02k Source Analyst x6 Analyst x4 Analyst x1 Analyst x1 Est @ 0.98% Present Value Discounted @ 13.14% \$508.14 \$454.44 \$628.96 \$618.14 \$551.66

Present Value of 5-year Cash Flow (PVCF)= US\$2.8b

The second stage is also known as Terminal Value, this is the business’s cash flow after 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 13.1%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US\$1.0b × (1 + 2.9%) ÷ (13.1% – 2.9%) = US\$10.3b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$10.3b ÷ ( 1 + 13.1%)5 = US\$5.6b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US\$8.3b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of \$33.81. Compared to the current share price of \$35.76, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

Important assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Aramark 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 13.1%, which is based on a levered beta of 1.446. 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. For ARMK, I’ve put together three pertinent aspects you should look at:

1. Financial Health: Does ARMK 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 ARMK’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 ARMK? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks 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.