Calculating The Fair Value Of Penske Automotive Group, Inc. (NYSE:PAG)
How far is Penske Automotive Group, Inc. (NYSE: PAG) from its intrinsic worth? Using the latest financial data, we'll test if the stock is fair priced by converting the company's forecast future cash flows back to today's value. On this occasion we use the DCF (Discounted Cash Flow) model. Don't let the jargon put you off, the math behind it is actually pretty simple.
Remember, however, that there are many ways to appreciate a company's value, and a DCF is just one method. For those familiar with stock analysis, the Simply Wall St analytical model might be of interest here.
Check out our latest analysis for the Penske Automotive Group
Is the Penske Automotive Group rated fairly?
We are going to use a two-stage DCF model which, as the name suggests, takes two stages of growth into account. The first phase is generally a higher growth phase that flattens out towards the terminal value and is recorded in the second phase of "steady growth". First, we need to get estimates of the next ten years of cash flow. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the first few years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Hence, we need to discount the sum of these future cash flows to get a present value estimate:
10-year free cash flow forecast (FCF)
Leverage FCF ($, million)
$ 271.4 million
$ 332.9 million
$ 400.7 million
$ 625.2 million
$ 677.1 million
$ 716.1 million
$ 749.3 million
$ 778.2 million
$ 803.9 million
$ 827.5 million
Source for growth rate estimation
Est @ 5.75%
Est @ 4.64%
Est @ 3.86%
Est @ 3.31%
Est @ 2.93%
Present Value ($, Million) Discounted by 12%
US $ 242
US $ 264
US $ 394
US $ 381
US $ 359
US $ 335
US $ 310
US $ 262
("Est" = FCF growth rate, estimated by Simply Wall St)
Present Value of 10 Year Cash Flow (PVCF) = $ 3.1 billion
The second level is also known as Terminal Value. This is the company's cash flow after the first stage. A very conservative growth rate is used that cannot exceed that of any country's GDP growth for a number of reasons. In this case, we used the 5-year average 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year growth period, we discount future cash flows to today's value using a cost of equity rate of 12%.
End Value (TV) = FCF2030 × (1 + g) ÷ (r - g) = $ 827M × (1 + 2.0%) ÷ (12% - 2.0%) = $ 8.3 billion
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = $ 8.3 billion ÷ (1 + 12%) 10 = $ 2.6 billion
The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, which results in the total net present value, which in this case is $ 5.7 billion. To get the intrinsic value per share, we divide this by the total number of shares issued. Based on the current share price of $ 81.5, the company appears at fair value at the time of writing. The assumptions in any calculation have a huge impact on the valuation, so it is better to think of this as a rough estimate that is not accurate to the last cent.
The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclical nature of an industry or a company's future capital requirements, so it does not give a complete picture of a company's potential performance. Given that we consider Penske Automotive Group to be a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) responsible for debt. In this calculation we used 12% based on a leverage beta of 1.944. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Assessment is only one side of the coin in creating your investment thesis and just one of many factors that you need to evaluate for a company. With a DCF model, it is not possible to get a foolproof rating. Instead, the best use for a DCF model is to test certain assumptions and theories to see if they would result in the company becoming undervalued or overvalued. For example, changes in the company's cost of equity or the risk-free rate can have a significant impact on the valuation. For the Penske Automotive Group we have put together three basic aspects that you should consider:
Risks: Every company has them, and we've spotted 4 warning signs for Penske Automotive Group that you should know about.
Future Outcome: What is PAG's growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
Other high-quality alternatives: do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else you might be missing!
PS. Simply Wall St updates its DCF calculation for every American share on a daily basis. So if you want to find out the intrinsic value of any other stock, just search here.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
Do you have any feedback on this article? Concerned about the content? Contact us. Alternatively, you can also send an email to the editorial team (at) simplywallst.com.
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