Key Insights
-
Using the 2 Stage Free Cash Flow to Equity, GE HealthCare Technologies fair value estimate is US$174
-
Current share price of US$87.96 suggests GE HealthCare Technologies is potentially 49% undervalued
-
Our fair value estimate is 85% higher than GE HealthCare Technologies’ analyst price target of US$94.09
How far off is GE HealthCare Technologies Inc. (NASDAQ:GEHC) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for GE HealthCare Technologies
The Calculation
We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) forecast
2024 |
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
|
Levered FCF ($, Millions) |
US$1.84b |
US$1.63b |
US$3.10b |
US$3.52b |
US$3.87b |
US$4.17b |
US$4.43b |
US$4.65b |
US$4.84b |
US$5.02b |
Growth Rate Estimate Source |
Analyst x2 |
Analyst x1 |
Analyst x1 |
Est @ 13.42% |
Est @ 10.08% |
Est @ 7.74% |
Est @ 6.11% |
Est @ 4.96% |
Est @ 4.16% |
Est @ 3.60% |
Present Value ($, Millions) Discounted @ 7.0% |
US$1.7k |
US$1.4k |
US$2.5k |
US$2.7k |
US$2.8k |
US$2.8k |
US$2.8k |
US$2.7k |
US$2.6k |
US$2.5k |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$25b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. 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 (2.3%) 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 7.0%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$5.0b× (1 + 2.3%) ÷ (7.0%– 2.3%) = US$108b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$108b÷ ( 1 + 7.0%)10= US$55b
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$79b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$88.0, the company appears quite good value at a 49% 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
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 GE HealthCare Technologies 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 7.0%, which is based on a levered beta of 1.032. 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 GE HealthCare Technologies
Strength
Weakness
Opportunity
Threat
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the sole piece of analysis you scrutinize for 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For GE HealthCare Technologies, we’ve put together three pertinent items you should explore:
-
Risks: Case in point, we’ve spotted 2 warning signs for GE HealthCare Technologies you should be aware of.
-
Future Earnings: How does GEHC’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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.
link