Is Option Care Health, Inc. (NASDAQ:OPCH) Trading At A 42% Discount?

OPTION CARE HEALTH INC +1.33%

OPTION CARE HEALTH INC

OPCH

31.32

+1.33%

Key Insights

  • The projected fair value for Option Care Health is US$57.00 based on 2 Stage Free Cash Flow to Equity
  • Option Care Health's US$33.18 share price signals that it might be 42% undervalued
  • The US$39.57 analyst price target for OPCH is 31% less than our estimate of fair value

How far off is Option Care Health, Inc. (NASDAQ:OPCH) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Option Care Health

The Method

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. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$284.1m US$307.2m US$372.0m US$385.7m US$398.3m US$410.1m US$421.5m US$432.5m US$443.4m US$454.3m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Est @ 3.68% Est @ 3.26% Est @ 2.97% Est @ 2.77% Est @ 2.62% Est @ 2.52% Est @ 2.45%
Present Value ($, Millions) Discounted @ 6.0% US$268 US$274 US$313 US$306 US$298 US$290 US$281 US$272 US$263 US$254

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.8b

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 6.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$454m× (1 + 2.3%) ÷ (6.0%– 2.3%) = US$13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$13b÷ ( 1 + 6.0%)10= US$7.1b

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$9.9b. 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$33.2, the company appears quite undervalued at a 42% 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
NasdaqGS:OPCH Discounted Cash Flow March 28th 2024

The 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 Option Care 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 6.0%, which is based on a levered beta of 0.800. 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 Option Care Health

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • No major weaknesses identified for OPCH.
Opportunity
  • Annual revenue is forecast to grow faster than the American market.
  • Good value based on P/E ratio and estimated fair value.
  • Significant insider buying over the past 3 months.
Threat
  • Annual earnings are forecast to decline for the next 3 years.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Option Care Health, there are three pertinent elements you should consider:

  1. Risks: For example, we've discovered 3 warning signs for Option Care Health (1 can't be ignored!) that you should be aware of before investing here.
  2. Future Earnings: How does OPCH'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 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.

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