Estimating The Intrinsic Value Of Papa John's International, Inc. (NASDAQ:PZZA)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Papa John's International fair value estimate is US$36.21
• Current share price of US$33.71 suggests Papa John's International is potentially trading close to its fair value
• Our fair value estimate is 28% lower than Papa John's International's analyst price target of US$50.36

Today we will run through one way of estimating the intrinsic value of Papa John's International, Inc. (NASDAQ:PZZA) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

We've discovered 3 warning signs about Papa John's International. View them for free.

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, 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$75.3m	US$81.4m	US$86.2m	US$90.4m	US$94.3m	US$97.9m	US$101.3m	US$104.6m	US$107.9m	US$111.1m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 5.85%	Est @ 4.92%	Est @ 4.27%	Est @ 3.81%	Est @ 3.49%	Est @ 3.27%	Est @ 3.12%	Est @ 3.01%
Present Value ($, Millions) Discounted @ 9.9%	US$68.5	US$67.4	US$64.9	US$61.9	US$58.7	US$55.5	US$52.2	US$49.1	US$46.0	US$43.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$567m

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 (2.8%) 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 9.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$111m× (1 + 2.8%) ÷ (9.9%– 2.8%) = US$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.6b÷ ( 1 + 9.9%)¹⁰= US$617m

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$1.2b. 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$33.7, the company appears about fair value at a 6.9% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 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 9.9%, which is based on a levered beta of 1.658. 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.

View our latest analysis for Papa John's International

SWOT Analysis for Papa John's International

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. 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. For Papa John's International, there are three fundamental aspects you should look at:

1. Risks: Take risks, for example - Papa John's International has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
2. 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.
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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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.