Estimating The Intrinsic Value Of Bellway p.l.c. (LON:BWY)

Key Insights

• The projected fair value for Bellway is UK£23.22 based on 2 Stage Free Cash Flow to Equity

• With UK£24.64 share price, Bellway appears to be trading close to its estimated fair value

• Analyst price target for BWY is UK£30.04, which is 29% above our fair value estimate

Does the April share price for Bellway p.l.c. (LON:BWY) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ 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.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Bellway

What's The Estimated Valuation?

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. 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, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£50.3m	UK£131.3m	UK£114.7m	UK£149.0m	UK£174.7m	UK£196.7m	UK£215.0m	UK£230.0m	UK£242.4m	UK£252.8m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x5	Analyst x1	Est @ 17.26%	Est @ 12.57%	Est @ 9.29%	Est @ 7.00%	Est @ 5.39%	Est @ 4.27%
Present Value (£, Millions) Discounted @ 8.4%	UK£46.4	UK£112	UK£90.0	UK£108	UK£117	UK£121	UK£122	UK£120	UK£117	UK£113

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.1b

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 (1.6%) 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£253m× (1 + 1.6%) ÷ (8.4%– 1.6%) = UK£3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£3.8b÷ ( 1 + 8.4%)¹⁰= UK£1.7b

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£2.8b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£24.6, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Bellway 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 8.4%, which is based on a levered beta of 1.237. 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 Bellway

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

• Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

• Dividends are not covered by cash flow.

• Revenue is forecast to grow slower than 20% per year.

Moving On:

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. 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 Bellway, we've put together three fundamental items you should further research:

1. Risks: For instance, we've identified 1 warning sign for Bellway that you should be aware of.

2. Future Earnings: How does BWY'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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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.