A Look At The Intrinsic Value Of Quest Resource Holding Corporation (NASDAQ:QRHC)
Key Insights
The projected fair value for Quest Resource Holding is US$5.98 based on 2 Stage Free Cash Flow to Equity
Current share price of US$7.08 suggests Quest Resource Holding is potentially trading close to its fair value
Industry average of 9.4% suggests Quest Resource Holding's peers are currently trading at a lower premium to fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Quest Resource Holding Corporation (NASDAQ:QRHC) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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 Quest Resource Holding
Step By Step Through The Calculation
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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$16.1m | US$11.3m | US$8.83m | US$7.53m | US$6.81m | US$6.41m | US$6.18m | US$6.07m | US$6.04m | US$6.05m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Est @ -21.89% | Est @ -14.64% | Est @ -9.56% | Est @ -6.00% | Est @ -3.52% | Est @ -1.77% | Est @ -0.55% | Est @ 0.30% |
Present Value ($, Millions) Discounted @ 7.3% | US$15.0 | US$9.8 | US$7.1 | US$5.7 | US$4.8 | US$4.2 | US$3.8 | US$3.4 | US$3.2 | US$3.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$60m
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$6.1m× (1 + 2.3%) ÷ (7.3%– 2.3%) = US$123m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$123m÷ ( 1 + 7.3%)10= US$61m
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$121m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$7.1, the company appears around fair value at the time of writing. 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
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 Quest Resource Holding 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 7.3%, which is based on a levered beta of 1.095. 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 Quest Resource Holding
Strength
Debt is well covered by .
Weakness
Interest payments on debt are not well covered.
Expensive based on P/S ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Expected to breakeven next year.
Threat
Debt is not well covered by operating cash flow.
Has less than 3 years of cash runway based on current free cash flow.
Moving On:
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. 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. 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. For Quest Resource Holding, we've put together three pertinent items you should look at:
Risks: As an example, we've found 2 warning signs for Quest Resource Holding that you need to consider before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for QRHC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.
