Yahoo Finance Is J D Wetherspoon plc (LON:JDW) Trading At A 30% Discount?
Does the April share price for J D Wetherspoon plc (LON:JDW) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the foreast future cash flows of the company and discounting them back to today's value. This is done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for J D Wetherspoon
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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | |
Levered FCF (£, Millions) | UK£82.8m | UK£113.5m | UK£126.8m | UK£136.0m | UK£143.2m | UK£148.7m | UK£152.9m | UK£156.2m | UK£158.8m | UK£160.9m |
Growth Rate Estimate Source | Analyst x3 | Analyst x6 | Analyst x4 | Est @ 7.3% | Est @ 5.27% | Est @ 3.84% | Est @ 2.85% | Est @ 2.15% | Est @ 1.67% | Est @ 1.33% |
Present Value (£, Millions) Discounted @ 12% | UK£74.2 | UK£91.2 | UK£91.3 | UK£87.8 | UK£82.8 | UK£77.1 | UK£71.1 | UK£65.1 | UK£59.3 | UK£53.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£753m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 0.5%. We discount the terminal cash flows to today's value at a cost of equity of 12%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = UK£161m× (1 + 0.5%) ÷ 12%– 0.5%) = UK£1.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£1.5b÷ ( 1 + 12%)10= UK£491m
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£1.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£8.5, the company appears a touch undervalued at a 30% 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.
The assumptions
We would 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 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 J D Wetherspoon 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 12%, which is based on a levered beta of 1.818. 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.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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. What is the reason for the share price to differ from the intrinsic value? For J D Wetherspoon, There are three fundamental aspects you should further research:
Risks: Be aware that J D Wetherspoon is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for JDW'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. 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
