One of the most common methods used to reveal the intrinsic valuation of a firm is the McKinsey free cash flow model. This model takes into account forecasts ten years into the future for items such as the firms long term growth rate, COGS as a percent of revenues, selling & general administrative expenses as a percent of revenue, and change in net operating assets as a percent of revenues. These forecasts are specific to the firm and based primarily off of historical data and trends in the industry. In the McKinsey model, the firms intrinsic valuation is equal to the present value of its cash flow and the net cash flow remaining for investors in each period. Using sources such as Fact Set, Value Line, and S&P Capital IQ, I was able to perform a free cash flow valuation on Host to determine its true value as a firm. 

Free Cash Flow Model

In order to uncover Host's true intrinsic value as a firm, the first step I took to begin the free cash flow valuation was determining a forecasting period for major metrics which you can see in figure 4.7 down below. 

Horizon Period Forecast

I chose to use a 10 year forecasting period as seen in figure 4.7 because I believed that it would provide the firm with enough business cycles to reach maturity and its long term growth rate. Another reason I chose to use a 10 year horizon window is because of how COVID-19 disrupted the firms normal cycles of business. I felt it would be best to give the firm time to recover from the drastic losses and negative impacts on financial statements still lingering from fiscal year 2020. 

After determining my horizon period, I forecasted key elements starting with the company's long term growth rate. As you can see in the figure above the growth rate for FY 2022 is 66.5% which is quite drastic, 6.46% for 2023, and 2.75% for FY 2024. I was able to confidently forecast these first three years of the proforma by pulling sales forecasts from Value Line and Fact Set for each year. I took the average of both the Value Line and Fact Set estimations for FY 2022 and divided it by the previous years revenues (2021) and subtracted one. This gave me the growth rate for FY 2022. Although 66.5% growth in revenues seems steep, keep in mind that this is expected as revenues return to normal following the pandemic. For the second and third year of my proforma, I averaged both forecasts from Fact Set and Value Line for that year divided by the previous years average and then minus one. After I was confident in the first three years of estimation, I adjusted the growth rate to gradually decrease over the next 7 years to reach its maturity rate of 2.5% at the end of the horizon period. 

As for the COGS proforma which was represented in figure 4.7 as a percent of sales, I tested out a similar method as described above using average COGS forecasts from Fact Set and Value Line. After pulling the values and making the calculations, I came to realize the estimation was far too low and would not represent an accurate forecast. Since these values were non meaningful, I pulled previously calculated values from my vertical analysis of the company's income statement. I was confident to represent COGS as 71% of revenue's for the entire horizon period in figure 4.7 since it was consistent in the vertical analysis for all years except COVID. 

As for SG&A as a % of sales and depreciation & amortization as a % of sales I used the same processes as mentioned above since both were a consistent value in the vertical analysis I previously conducted. 

As for change in NOA as a percent of sales, the two components that I averaged for this value were the following: (1) The 2020-2021 average without outliers of the change in FCF resulting from an increase in NOA and (2) The 2020-2021 average without outliers of the change in FCF from depreciation- change in working capital- CapEx. I essentially took an average of two averages which gave me NOA as a % of revenues as 4.46% for the entire horizon period. 

** Full calculations for Horizon Period Forecast be found in the attached Excel file here

Income Statment Forecast

After forecasting the horizon period and major metrics such as growth for the 10 year period, I forecasted values on the income statement ranging from revenues to operating income as seen in figure 4.8. 

The first account I forecasted was revenues where I took the revenues from each previous year and multiplied it by one plus the forecasted growth rate for the respective year. At the end of the horizon period, revenues are expected to reach maturity at $6,175 million. 

After forecasting revenue up until 2032, I forecasted COGS, which was simply the estimated COGS expense for the respective year multiplied by the respective forecasted revenues for that year. 

Gross profit was estimated by using the forecasted revenue minus the forecasted COGS for the year being estimated. Gross profit was estimated to reach a maturity of $1,780 million in 2032. 

SG&A as a value was simply estimated as the predicted % of sales (1.87%) multiplied by the predicted revenues.

The forecasted tax rate was estimated by the previous vertical analysis I calculated of the income statement. I divided the income tax expense each year by EBT including unusual items to get the income tax as a percent of sales. Income tax as a percent of sales was consistent at 12% for the years prior to COVID-19, therefore I used this value as the forecasted tax rate throughout the horizon period. 

In general, the income statement proforma in figure 4.8 above shows that Host is on track for consistent growth up until its maturity date. Major accounts such as revenue, gross profit, and operating income increase from the start of the horizon period until the end. One thing Host should aim to do to generate more income at the end of the day is to minimize its COGS expense since it also increases with the horizon period. 

** Full calculations for Income Statement Forecast can be found in the attached Excel file here

FCF Valuation up to 2031

As seen in figure 4.9 above, I combined model one and two of the FCF valuation to get the terminal value of the total free cash flow in 2031. Total free cash flow was calculated for every year of the horizon period by subtracting the statutory tax rate from EBIT minus the increase in NOA. After calculating the free cash flow for each year, which represents how much cash the company has on hand after paying all business related expenses, I calculated the terminal value of cash flow in 2031. This was represented by taking the final free cash flow in 2032 ($793 million) and dividing it by the WACC (8.54%) minus the long-term terminal growth rate in 2032 (2.5%). I then added the terminal value to the free cash flow in 2031 to finally get $14,158 million which represents the company's total value at full maturity. 

** Full calculations for FCF valuation model can be found in the attached Excel file here

Estimated Value per Share

After I forecasted the the free cash flows for each year of the horizon period and the terminal value at maturity, I calculated the value per share as depicted in figure 5.0 above. The value per share represents the true value per share in comparison to the going market price per share. This helps investors decide if the market price is overvaluing or undervaluing the asset and if it would be a good time to buy or sell. 

The first step I took in calculating the value per share was was to determine the enterprise value, I took the NPV of all of the cash flows in the horizon period using the WACC. I then retrieved the value of excess assets (cash) from the balance sheet in 2021 and the value of debt from my prior cost of capital calculations. I got the value of equity by adding the enterprise value with the value of excess cash and subtracting the value of debt to get $7,351. I then sought out the number of outstanding shares of the stock in millions from Value Line and multiplied it by the value of equity to give me the value per share as finally desired which was $13.09.

Now having the true value per share according to my model, I was able to compare it to the actual price per share on the market. As of market close on December 9th, 2022, the market price per share of HST was $17.69. This means that HST is overvalued by about $4 per share according to my model and now would most likely not be a good time to buy. 

When reflecting upon the entire free cash flow valuation, it seems to be that HST is in decent financial standing and on track for slow, but steady growth until it hits maturity. Although it is predicted to grow rapidly with the next year or two, it is important to keep in mind this is due to recovering revenues from the pandemic and its growth rates will decrease in a timely manner. Over the horizon period, major accounts such as revenue, gross profit, and operating income will increase slowly. To increase net income without challenging the growth rate of revenues, HST can aim to minimize the COGS and SG&A expense. 

** Full calculations for HST Value per Share can be found in the attached Excel file here