Yahoo Finance Is There An Opportunity With Greene King plc’s (LON:GNK) 25.73% Undervaluation?
In this article I am going to calculate the intrinsic value of Greene King plc (LON:GNK) by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. 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. Please also note that this article was written in January 2019 so be sure check out the updated calculation by following the link below.
Check out our latest analysis for Greene King
Want to help shape the future of investing tools? Participate in a short research study and receive a subscription valued at $60.
Crunching the numbers
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. 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) | £164.00 | £148.12 | £184.07 | £210.33 | £240.34 |
Source | Analyst x5 | Analyst x6 | Analyst x6 | Est @ 14.26% | Est @ 14.26% |
Present Value Discounted @ 9.85% | £149.29 | £122.74 | £138.85 | £144.43 | £150.23 |
Present Value of 5-year Cash Flow (PVCF)= UK£706m
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 (1.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.9%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = UK£240m × (1 + 1.2%) ÷ (9.9% – 1.2%) = UK£2.8b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£2.8b ÷ ( 1 + 9.9%)5 = UK£1.8b
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£2.5b. 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 £7.97. Relative to the current share price of £5.92, the stock is about right, perhaps slightly undervalued at a 26% discount to what it is available for right now.
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. 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 Greene King 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 9.9%, which is based on a levered beta of 0.983. 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 GNK, there are three pertinent factors you should further examine:
Financial Health: Does GNK 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 GNK’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 GNK? 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 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.
