Phibro Animal Health Corporation (NASDAQ:PAHC) Shares Could Be 28% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Phibro Animal Health is US$17.84 based on 2 Stage Free Cash Flow to Equity

• Current share price of US$12.88 suggests Phibro Animal Health is potentially 28% undervalued

• The US$10.75 analyst price target for PAHC is 40% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Phibro Animal Health Corporation (NASDAQ:PAHC) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Phibro Animal Health

Step By Step Through 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. To begin with, we have to get estimates of the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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$36.7m	US$16.4m	US$21.1m	US$33.4m	US$33.2m	US$33.3m	US$33.5m	US$34.0m	US$34.5m	US$35.1m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ -0.67%	Est @ 0.22%	Est @ 0.84%	Est @ 1.28%	Est @ 1.58%	Est @ 1.79%
Present Value ($, Millions) Discounted @ 6.2%	US$34.6	US$14.5	US$17.6	US$26.2	US$24.5	US$23.1	US$22.0	US$21.0	US$20.0	US$19.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$223m

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 6.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$35m× (1 + 2.3%) ÷ (6.2%– 2.3%) = US$914m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$914m÷ ( 1 + 6.2%)¹⁰= US$500m

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$722m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$12.9, the company appears a touch undervalued at a 28% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

Important Assumptions

Now 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 Phibro Animal Health 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 6.2%, which is based on a levered beta of 0.855. 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 Phibro Animal Health

Strength

• Debt is well covered by earnings.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

• Trading below our estimate of fair value by more than 20%.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by earnings.

• Annual revenue is forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 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 Phibro Animal Health, we've compiled three further elements you should explore:

1. Risks: Take risks, for example - Phibro Animal Health has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

2. Future Earnings: How does PAHC'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGM every day. If you want to find the calculation for other stocks 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.