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Herc Holdings Inc.'s (NYSE:HRI) Intrinsic Value Is Potentially 43% Above Its Share Price

Key Insights

  • Herc Holdings' estimated fair value is US$239 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$168 suggests Herc Holdings is potentially 30% undervalued

  • Our fair value estimate is 31% higher than Herc Holdings' analyst price target of US$183

How far off is Herc Holdings Inc. (NYSE:HRI) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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View our latest analysis for Herc Holdings

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$416.2m

US$294.7m

US$414.0m

US$546.0m

US$569.0m

US$588.0m

US$605.8m

US$622.8m

US$639.3m

US$655.5m

Growth Rate Estimate Source

Analyst x5

Analyst x3

Analyst x3

Analyst x1

Analyst x1

Est @ 3.34%

Est @ 3.02%

Est @ 2.80%

Est @ 2.65%

Est @ 2.54%

Present Value ($, Millions) Discounted @ 9.7%

US$380

US$245

US$314

US$378

US$359

US$338

US$318

US$298

US$279

US$261

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.2b

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.7%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$656m× (1 + 2.3%) ÷ (9.7%– 2.3%) = US$9.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.1b÷ ( 1 + 9.7%)10= US$3.6b

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$6.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$168, the company appears a touch undervalued at a 30% 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.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 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 accounts for debt. In this calculation we've used 9.7%, which is based on a levered beta of 1.601. 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 Herc Holdings

Strength

  • Debt is well covered by cash flow.

Weakness

  • Earnings growth over the past year underperformed the Trade Distributors industry.

  • Interest payments on debt are not well covered.

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

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Paying a dividend but company has no free cash flows.

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

Moving On:

Whilst important, the DCF calculation 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. 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 Herc Holdings, there are three fundamental aspects you should further examine:

  1. Risks: We feel that you should assess the 3 warning signs for Herc Holdings (1 is concerning!) we've flagged before making an investment in the company.

  2. Future Earnings: How does HRI'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.