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A Look At The Intrinsic Value Of Patterson Companies, Inc. (NASDAQ:PDCO)

Key Insights

  • The projected fair value for Patterson Companies is US$27.13 based on 2 Stage Free Cash Flow to Equity

  • With US$28.82 share price, Patterson Companies appears to be trading close to its estimated fair value

  • Our fair value estimate is 20% higher than Patterson Companies' analyst price target of US$32.50

Today we will run through one way of estimating the intrinsic value of Patterson Companies, Inc. (NASDAQ:PDCO) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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Check out our latest analysis for Patterson Companies

The Model

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. 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, 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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$47.0m

US$96.0m

US$115.0m

US$129.1m

US$140.9m

US$150.8m

US$159.2m

US$166.4m

US$172.7m

US$178.3m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Est @ 12.23%

Est @ 9.18%

Est @ 7.05%

Est @ 5.55%

Est @ 4.51%

Est @ 3.78%

Est @ 3.26%

Present Value ($, Millions) Discounted @ 7.1%

-US$43.9

US$83.7

US$93.6

US$98.1

US$100

US$100.0

US$98.5

US$96.1

US$93.2

US$89.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$809m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$178m× (1 + 2.1%) ÷ (7.1%– 2.1%) = US$3.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.6b÷ ( 1 + 7.1%)10= US$1.8b

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$2.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$28.8, 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.

dcf
dcf

The 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 these result, have a go at the calculation yourself and play with the 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 Patterson Companies 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 0.846. 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 Patterson Companies

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings.

Weakness

  • Dividend is low compared to the top 25% of dividend payers in the Healthcare market.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Debt is not well covered by operating cash flow.

  • Paying a dividend but company has no free cash flows.

  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Patterson Companies, we've compiled three important factors you should further research:

  1. Risks: For example, we've discovered 3 warning signs for Patterson Companies (2 are significant!) that you should be aware of before investing here.

  2. Future Earnings: How does PDCO'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 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.

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.

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