Yahoo Finance Investors Are Undervaluing Galliford Try plc (LON:GFRD) By 20.65%
Does the share price for Galliford Try plc (LON:GFRD) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present value. I will use 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 Galliford Try by following the link below. See our latest analysis for Galliford Try
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 start off with we need to estimate 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. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
2018 | 2019 | 2020 | 2021 | 2022 | |
Levered FCF (£, Millions) | £-9.93 | £77.95 | £89.60 | £102.10 | £116.34 |
Source | Analyst x1 | Analyst x1 | Analyst x1 | Extrapolated @ (13.94%) | Extrapolated @ (13.94%) |
Present Value Discounted @ 8.64% | £-9.14 | £66.04 | £69.87 | £73.28 | £76.86 |
Present Value of 5-year Cash Flow (PVCF)= UK£276.91m
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 the GDP. In this case I have used the 10-year government bond rate (1.4%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.6%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£116.34m × (1 + 1.4%) ÷ (8.6% – 1.4%) = UK£1.63b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£1.63b ÷ ( 1 + 8.6%)5 = UK£1.08b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£1.35b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of £12.22. Relative to the current share price of £9.7, the stock is about right, perhaps slightly undervalued at a 20.65% discount to what it is available for right now.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Galliford Try 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 8.6%, which is based on a levered beta of 0.842. 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:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 GFRD, I’ve put together three important aspects you should look at:
Financial Health: Does GFRD 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.
Future Earnings: How does GFRD’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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of GFRD? 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.
