Estimating The Intrinsic Value Of InterContinental Hotels Group PLC (LON:IHG)
Key Insights
InterContinental Hotels Group's estimated fair value is UK£63.67 based on 2 Stage Free Cash Flow to Equity
With UK£54.30 share price, InterContinental Hotels Group appears to be trading close to its estimated fair value
The US$58.63 analyst price target for IHG is 7.9% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of InterContinental Hotels Group PLC (LON:IHG) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for InterContinental Hotels Group
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$598.1m | US$703.1m | US$743.1m | US$973.0m | US$1.09b | US$1.18b | US$1.25b | US$1.31b | US$1.35b | US$1.39b |
Growth Rate Estimate Source | Analyst x8 | Analyst x8 | Analyst x7 | Analyst x1 | Analyst x1 | Est @ 7.89% | Est @ 5.87% | Est @ 4.45% | Est @ 3.46% | Est @ 2.77% |
Present Value ($, Millions) Discounted @ 9.1% | US$548 | US$591 | US$573 | US$688 | US$709 | US$702 | US$681 | US$652 | US$619 | US$583 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$6.3b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 9.1%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$1.4b× (1 + 1.2%) ÷ (9.1%– 1.2%) = US$18b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$18b÷ ( 1 + 9.1%)10= US$7.5b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$14b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£54.3, the company appears about fair value at a 15% discount to where the stock price trades currently. 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.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 InterContinental Hotels Group 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 9.1%, which is based on a levered beta of 1.134. 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 InterContinental Hotels Group
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is well covered by earnings and cashflows.
Dividends are covered by earnings and cash flows.
Weakness
Earnings growth over the past year underperformed the Hospitality industry.
Dividend is low compared to the top 25% of dividend payers in the Hospitality market.
Opportunity
Annual earnings are forecast to grow faster than the British market.
Good value based on P/E ratio and estimated fair value.
Threat
Total liabilities exceed total assets, which raises the risk of financial distress.
Annual revenue is expected to decline over the next 3 years.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 InterContinental Hotels Group, we've compiled three fundamental factors you should assess:
Risks: Be aware that InterContinental Hotels Group is showing 3 warning signs in our investment analysis , you should know about...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for IHG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock 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.
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