A Look At The Intrinsic Value Of The Pennant Group, Inc. (NASDAQ:PNTG)
Key Insights
Pennant Group's estimated fair value is US$12.51 based on 2 Stage Free Cash Flow to Equity
Pennant Group's US$13.15 share price indicates it is trading at similar levels as its fair value estimate
The US$14.50 analyst price target for PNTG is 16% more than our estimate of fair value
How far off is The Pennant Group, Inc. (NASDAQ:PNTG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Pennant Group
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$19.0m | US$19.2m | US$19.5m | US$19.8m | US$20.1m | US$20.5m | US$20.9m | US$21.4m | US$21.8m | US$22.3m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Est @ 1.34% | Est @ 1.60% | Est @ 1.79% | Est @ 1.92% | Est @ 2.01% | Est @ 2.07% | Est @ 2.12% | Est @ 2.15% |
Present Value ($, Millions) Discounted @ 7.1% | US$17.7 | US$16.7 | US$15.8 | US$15.0 | US$14.3 | US$13.6 | US$12.9 | US$12.3 | US$11.7 | US$11.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$141m
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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$22m× (1 + 2.2%) ÷ (7.1%– 2.2%) = US$464m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$464m÷ ( 1 + 7.1%)10= US$233m
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$374m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$13.2, the company appears around fair value at the time of writing. 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
Now 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 Pennant Group 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 7.1%, which is based on a levered beta of 0.982. 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 Pennant Group
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Weakness
No major weaknesses identified for PNTG.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
Annual revenue is forecast to grow slower than the American market.
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. It's not possible to obtain a foolproof valuation with a DCF model. 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. For Pennant Group, we've put together three pertinent elements you should consider:
Financial Health: Does PNTG 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.
Future Earnings: How does PNTG'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.
