Is Cobham plc (LON:COB) Expensive For A Reason? A Look At The Intrinsic Value

I am going to run you through how I calculated the intrinsic value of Cobham plc (LON:COB) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Cobham by following the link below. Check out our latest analysis for Cobham

Step by step through the calculation

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 five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2018	2019	2020	2021	2022
Levered FCF (£, Millions)	£41.33	£123.96	£158.90	£181.00	£187.25
Source	Analyst x6	Analyst x9	Analyst x6	Analyst x1	Extrapolated @ (3.45%)
Present Value Discounted @ 8.28%	£38.17	£105.73	£125.16	£131.67	£125.81

Present Value of 5-year Cash Flow (PVCF)= UK£526.54m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.4%. We discount this to today’s value at a cost of equity of 8.3%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = UK£187.25m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£2.76b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = UK£2.76b ÷ ( 1 + 8.3%)⁵ = UK£1.85b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£2.38b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of £1. Compared to the current share price of £1.3, the stock is fair value, maybe slightly overvalued at the time of writing.

LSE:COB Intrinsic Value June 23rd 18

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Cobham as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.3%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For COB, I’ve compiled three pertinent factors you should look at:

1. Financial Health: Does COB have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future Earnings: How does COB’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: Are there other high quality stocks you could be holding instead of COB? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.