Advantage Solutions' estimated fair value is US$5.96 based on 2 Stage Free Cash Flow to Equity
Advantage Solutions' US$3.60 share price signals that it might be 40% undervalued
The US$4.50 analyst price target for ADV is 24% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Advantage Solutions Inc. (NASDAQ:ADV) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$133.8m
US$130.5m
US$129.2m
US$129.3m
US$130.4m
US$132.1m
US$134.3m
US$136.8m
US$139.7m
US$142.8m
Growth Rate Estimate Source
Est @ -4.58%
Est @ -2.46%
Est @ -0.97%
Est @ 0.07%
Est @ 0.80%
Est @ 1.31%
Est @ 1.67%
Est @ 1.92%
Est @ 2.09%
Est @ 2.21%
Present Value ($, Millions) Discounted @ 8.6%
US$123
US$111
US$101
US$92.9
US$86.2
US$80.3
US$75.2
US$70.5
US$66.3
US$62.4
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$868m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.5%) 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 8.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.4b÷ ( 1 + 8.6%)10= US$1.0b
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$1.9b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$3.6, the company appears quite good value at a 40% 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.
NasdaqGS:ADV Discounted Cash Flow August 16th 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 Advantage Solutions 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 8.6%, which is based on a levered beta of 1.490. 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 Advantage Solutions
Strength
No major strengths identified for ADV.
Weakness
Interest payments on debt are not well covered.
Opportunity
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 ADV insiders been buying lately?
Threat
Debt is not well covered by operating cash flow.
Not expected to become profitable over the next 3 years.
Is ADV well equipped to handle threats?
Moving On:
Whilst important, the DCF calculation is only one of many factors that you need to assess 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 Advantage Solutions, we've compiled three important items you should consider:
Risks: Be aware that Advantage Solutions is showing 1 warning sign in our investment analysis , you should know about...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ADV's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 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.