Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Petco Health and Wellness Company fair value estimate is US$5.50
- Current share price of US$4.21 suggests Petco Health and Wellness Company is potentially 23% undervalued
- Our fair value estimate is 47% higher than Petco Health and Wellness Company's analyst price target of US$3.74
How far off is Petco Health and Wellness Company, Inc. (NASDAQ:WOOF) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$53.9m | US$35.3m | US$36.0m | US$139.0m | US$151.0m | US$160.2m | US$168.3m | US$175.6m | US$182.3m | US$188.6m |
| Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ 6.10% | Est @ 5.06% | Est @ 4.33% | Est @ 3.82% | Est @ 3.46% |
| Present Value ($, Millions) Discounted @ 11% | US$48.6 | US$28.7 | US$26.4 | US$92.0 | US$90.2 | US$86.3 | US$81.8 | US$77.0 | US$72.1 | US$67.3 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$670m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 11%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$189m× (1 + 2.6%) ÷ (11%– 2.6%) = US$2.3b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.3b÷ ( 1 + 11%)10= US$838m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$4.2, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important 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 Petco Health and Wellness Company 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 11%, which is based on a levered beta of 2.000. 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 Petco Health and Wellness Company
- No major strengths identified for WOOF.
- Shareholders have been diluted in the past year.
- Forecast to reduce losses next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Good value based on P/S ratio and estimated fair value.
- Have WOOF insiders been buying lately?
- Debt is not well covered by operating cash flow.
- Is WOOF well equipped to handle threats?
Next Steps:
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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. Can we work out why the company is trading at a discount to intrinsic value? For Petco Health and Wellness Company, we've put together three essential factors you should further examine:
- Risks: Take risks, for example - Petco Health and Wellness Company has 2 warning signs we think you should be aware of.
- Future Earnings: How does WOOF'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 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 is out there you may be missing!
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.
