Is There An Opportunity With Papa John's International, Inc.'s (NASDAQ:PZZA) 25% Undervaluation?

Simply Wall St.04-18

Key Insights Papa John's International's estimated fair value is US$81.10 based on 2 Stage Free Cash Flow to Equity Current share price of US$60.95 suggests Papa John's International is potentially ...

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(NASDAQ:PZZA) by taking the forecast future cash flows of the company and discounting them back to today's value.  One way to achieve this is by employing 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.  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.  Check out our latest analysis for Papa John's International  Is Papa John's International Fairly Valued?   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 start off with, we need to estimate 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) forecast  2024 2025 2026 2027 2028 2029 2030 2031 2032 2033  Levered FCF ($, Millions)  US$122.8m US$132.1m US$159.0m US$171.4m US$181.9m US$191.0m US$199.0m US$206.2m US$212.8m US$219.1m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x1 Est @ 7.80% Est @ 6.15% Est @ 4.99% Est @ 4.18% Est @ 3.61% Est @ 3.22% Est @ 2.94%  Present Value ($, Millions) Discounted @ 8.6%  US$113 US$112 US$124 US$123 US$120 US$116 US$112 US$106 US$101 US$95.8 (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = US$1.1b 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 (2.3%) 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 8.6%. Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$219m× (1 + 2.3%) ÷ (8.6%– 2.3%) = US$3.5bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.5b÷ ( 1 + 8.6%)10= US$1.5b 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$2.7b.  The last step is to then divide the equity value by the number of shares outstanding.  Relative to the current share price of US$61.0, the company appears   a touch undervalued    at a 25% discount to where the stock price trades currently.   The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent. NasdaqGS:PZZA Discounted Cash Flow April 18th 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 Papa John's International 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 1.376. 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 Papa John's InternationalStrength Earnings growth over the past year exceeded the industry. Debt is well covered by earnings and cashflows. Dividends are covered by earnings and cash flows.  Dividend information for PZZA. Weakness Earnings growth over the past year is below its 5-year average. Dividend is low compared to the top 25% of dividend payers in the Hospitality market.Opportunity Annual earnings are forecast to grow for the next 3 years. Trading below our estimate of fair value by more than 20%. ThreatTotal liabilities exceed total assets, which raises the risk of financial distress.  Annual earnings are forecast to grow slower than the American market. Is PZZA well equipped to handle threats?  Next Steps:  Although the valuation of a company is important, it  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 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 Papa John's International, we've put together three  essential  aspects  you should assess:   Risks: For example, we've discovered 1 warning sign for Papa John's International that you should be aware of before investing here.  Future Earnings: How does PZZA'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.Valuation is complex, but we're helping make it simple.Find out whether Papa John's International is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free AnalysisHave 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.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428578146"}