Is There An Opportunity With Enhabit, Inc.'s (NYSE:EHAB) 27% Undervaluation?
Key Insights
The projected fair value for Enhabit is US$12.26 based on 2 Stage Free Cash Flow to Equity
Current share price of US$8.93 suggests Enhabit is potentially 27% undervalued
Our fair value estimate is 14% higher than Enhabit's analyst price target of US$10.79
Today we will run through one way of estimating the intrinsic value of Enhabit, Inc. (NYSE:EHAB) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Enhabit
The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$53.6m | US$44.0m | US$38.8m | US$35.9m | US$34.2m | US$33.4m | US$33.0m | US$33.0m | US$33.2m | US$33.6m |
Growth Rate Estimate Source | Analyst x1 | Est @ -17.82% | Est @ -11.79% | Est @ -7.57% | Est @ -4.61% | Est @ -2.54% | Est @ -1.09% | Est @ -0.08% | Est @ 0.63% | Est @ 1.13% |
Present Value ($, Millions) Discounted @ 7.2% | US$50.0 | US$38.3 | US$31.5 | US$27.2 | US$24.2 | US$22.0 | US$20.3 | US$18.9 | US$17.7 | US$16.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$267m
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$34m× (1 + 2.3%) ÷ (7.2%– 2.3%) = US$698m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$698m÷ ( 1 + 7.2%)10= US$348m
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$615m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$8.9, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. 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.
The 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 Enhabit 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 7.2%, which is based on a levered beta of 1.069. 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 Enhabit
Strength
No major strengths identified for EHAB.
Weakness
Interest payments on debt are not well covered.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Enhabit, we've put together three pertinent items you should explore:
Risks: Every company has them, and we've spotted 1 warning sign for Enhabit you should know about.
Future Earnings: How does EHAB'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.
