Calculating The Intrinsic Value Of Haleon plc (LON:HLN)

Key Insights

• The projected fair value for Haleon is UK£3.15 based on 2 Stage Free Cash Flow to Equity

• Haleon's UK£3.45 share price indicates it is trading at similar levels as its fair value estimate

• The UK£3.47 analyst price target for HLN is 10% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Haleon plc (LON:HLN) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for Haleon

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£1.59b	UK£1.76b	UK£2.00b	UK£2.25b	UK£2.43b	UK£2.58b	UK£2.70b	UK£2.79b	UK£2.87b	UK£2.94b
Growth Rate Estimate Source	Analyst x7	Analyst x7	Analyst x6	Analyst x1	Est @ 8.02%	Est @ 5.96%	Est @ 4.52%	Est @ 3.51%	Est @ 2.80%	Est @ 2.30%
Present Value (£, Millions) Discounted @ 9.4%	UK£1.5k	UK£1.5k	UK£1.5k	UK£1.6k	UK£1.6k	UK£1.5k	UK£1.4k	UK£1.4k	UK£1.3k	UK£1.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£14b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£2.9b× (1 + 1.2%) ÷ (9.4%– 1.2%) = UK£36b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£36b÷ ( 1 + 9.4%)¹⁰= UK£15b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£29b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£3.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Haleon 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 9.4%, which is based on a levered beta of 1.180. 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 Haleon

Strength

• Debt is well covered by earnings.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the Personal Products market.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• Annual earnings are forecast to grow faster than the British market.

• Significant insider buying over the past 3 months.

Threat

• Debt is not well covered by operating cash flow.

• Annual revenue is forecast to grow slower than the British market.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Haleon, we've compiled three pertinent elements you should explore:

1. Risks: For example, we've discovered 3 warning signs for Haleon (1 can't be ignored!) that you should be aware of before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for HLN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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 LSE 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.

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