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Is There An Opportunity With Almost Family Inc’s (NASDAQ:AFAM) 23.52% Undervaluation?

In this article I am going to calculate the intrinsic value of Almost Family Inc (NASDAQ:AFAM) by estimating the company’s future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. 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. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Almost Family by following the link below.

Step by step through 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. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

 2018 2019 2020 2021 2022 Levered FCF (\$, Millions) \$42.67 \$43.70 \$53.00 \$62.01 \$71.93 Source Analyst x3 Analyst x2 Analyst x1 Extrapolated @ (17%, capped from 17.26%) Extrapolated @ (16%, capped from 17.26%) Present Value Discounted @ 8.49% \$39.33 \$37.13 \$41.50 \$44.75 \$47.85

Present Value of 5-year Cash Flow (PVCF)= US\$210.56m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. 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 (2.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.5%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US\$71.93m × (1 + 2.5%) ÷ (8.5% – 2.5%) = US\$1.22b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$1.22b ÷ ( 1 + 8.5%)5 = US\$813.96m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US\$1.02b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of \$73.22. Relative to the current share price of \$56, the stock is about right, perhaps slightly undervalued at a 23.52% discount to what it is available for right now.

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Almost Family 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 8.5%, which is based on a levered beta of 0.800. 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:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For AFAM, I’ve compiled three key factors you should further examine:

1. Financial Health: Does AFAM 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 AFAM’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 AFAM? 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 NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see pass 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.