The ONE Group Hospitality, Inc. (NASDAQ:STKS) Shares Could Be 28% Above Their Intrinsic Value Estimate
Key Insights
ONE Group Hospitality's estimated fair value is US$4.03 based on 2 Stage Free Cash Flow to Equity
ONE Group Hospitality is estimated to be 28% overvalued based on current share price of US$5.17
Analyst price target for STKS is US$11.13, which is 176% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of The ONE Group Hospitality, Inc. (NASDAQ:STKS) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for ONE Group Hospitality
Is ONE Group Hospitality Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$5.48m | US$7.11m | US$8.64m | US$9.99m | US$11.2m | US$12.1m | US$13.0m | US$13.7m | US$14.3m | US$14.8m |
Growth Rate Estimate Source | Analyst x2 | Est @ 29.72% | Est @ 21.45% | Est @ 15.66% | Est @ 11.61% | Est @ 8.77% | Est @ 6.78% | Est @ 5.39% | Est @ 4.42% | Est @ 3.74% |
Present Value ($, Millions) Discounted @ 11% | US$5.0 | US$5.8 | US$6.4 | US$6.7 | US$6.8 | US$6.7 | US$6.4 | US$6.1 | US$5.8 | US$5.4 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$61m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 11%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$15m× (1 + 2.2%) ÷ (11%– 2.2%) = US$180m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$180m÷ ( 1 + 11%)10= US$66m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$127m. 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$5.2, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
We would point out that 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 ONE Group Hospitality 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 11%, which is based on a levered beta of 1.674. 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 ONE Group Hospitality
Strength
Debt is well covered by cash flow.
Weakness
Earnings declined over the past year.
Interest payments on debt are not well covered.
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
Revenue is forecast to grow slower than 20% per year.
Looking Ahead:
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. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For ONE Group Hospitality, we've compiled three pertinent factors you should consider:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with ONE Group Hospitality (at least 2 which are significant) , and understanding these should be part of your investment process.
Future Earnings: How does STKS'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. 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.
