Is Herc Holdings Inc. (NYSE: HRI) worth US $ 171 based on intrinsic value?
How far is Herc Holdings Inc. (NYSE: HRI) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the lingo, the math is actually pretty straightforward.
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
Check out our latest analysis for Herc Holdings
What is the estimated valuation?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | -122.9 million US dollars | US $ 255.0 million | US $ 257.8 million | US $ 261.3 million | US $ 265.3 million | US $ 269.8 million | US $ 274.5 million | US $ 279.5 million | US $ 284.7 million | US $ 290.0 million |
Source of growth rate estimate | Analyst x3 | Analyst x1 | Is 1.1% | Est @ 1.36% | Est @ 1.54% | East @ 1.67% | Is @ 1.75% | East @ 1.82% | Est @ 1.86% | East @ 1.89% |
Present value (in millions of dollars) discounted at 7.8% | – $ 114 | US $ 219 | US $ 206 | 193 USD | $ 182 | $ 172 | US $ 162 | US $ 153 | 145 USD | US $ 137 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 1.5 billion
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.8%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 290 million × (1 + 2.0%) ÷ (7.8% to 2.0%) = US $ 5.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 5.1 billion ÷ (1 + 7.8%)^{ten}= US $ 2.4 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 3.8 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 171, the company looks potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
The hypotheses
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Herc Holdings 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 takes into account debt. In this calculation, we used 7.8%, which is based on a leveraged beta of 1.335. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
While a business valuation is important, ideally, it won’t be the only analysis you review for a business. DCF models are not the ultimate solution for investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Can we understand why the company is trading at a premium over intrinsic value? For Herc Holdings, there are three relevant things you should consider:
- Risks: Every company has them, and we have spotted 2 warning signs for Herc Holdings you should know.
- Future benefits: How does HRI’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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