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An Intrinsic Calculation For Greencore Group plc (LON:GNC) Shows It’s 37.46% Undervalued

In this article I am going to calculate the intrinsic value of Greencore Group plc (LON:GNC) by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Greencore Group by following the link below.

See our latest analysis for Greencore Group

The model

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

2019

2020

2021

2022

2023

Levered FCF (£, Millions)

£97.33

£109.20

£127.27

£148.33

£172.07

Source

Analyst x3

Analyst x3

Est @ 16.55%

Est @ 16.55%

Est @ 16%, capped from 16.55%

Present Value Discounted @ 8.28%

£89.89

£93.14

£100.25

£107.91

£115.60

Present Value of 5-year Cash Flow (PVCF)= UK£507m

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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£172m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£2.5b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£2.5b ÷ ( 1 + 8.3%)5 = UK£1.7b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is UK£2.2b. 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 £3.13. Relative to the current share price of £1.96, the stock is quite good value at a 37% discount to what it is available for right now.

LSE:GNC Intrinsic Value Export October 11th 18
LSE:GNC Intrinsic Value Export October 11th 18

Important assumptions

I’d like to point out that 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 Greencore Group 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 GNC, I’ve put together three relevant aspects you should further research:

  1. Financial Health: Does GNC 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 GNC’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 GNC? 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 for every stock on the LON every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.