Yahoo Finance A Look At The Fair Value Of Chemring Group PLC (LON:CHG)
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Chemring Group PLC (LON:CHG) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. This is done using 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 December 2018 then I highly recommend you check out the latest calculation for Chemring Group by following the link below.
View our latest analysis for Chemring Group
What’s the value?
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 begin with we have to get estimates of the next five years of cash flows. 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 estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (£, Millions) | £24.00 | £32.20 | £32.74 | £33.30 | £33.86 |
Source | Analyst x1 | Analyst x2 | Est @ 1.69% | Est @ 1.69% | Est @ 1.69% |
Present Value Discounted @ 8.28% | £22.16 | £27.46 | £25.79 | £24.22 | £22.75 |
Present Value of 5-year Cash Flow (PVCF)= UK£122m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. 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 8.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£34m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£499m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£499m ÷ ( 1 + 8.3%)5 = UK£335m
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£458m. 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 £1.63. Compared to the current share price of £1.67, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Chemring 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. For CHG, I’ve put together three essential factors you should further examine:
Financial Health: Does CHG 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 CHG’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 CHG? 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.
