Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Thefiberglass vs cellulose blown in City Pub Group plc (

LON:CPC

) as an investment opportunity 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 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 January 2019 then I highly recommend you check out the latest calculation for City Pub Group by following the link below.

View our latest analysis for City Pub Group

Crunching the numbers

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. To start off with we need to estimate 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)

£3.77

£5.18

£6.11

£7.15

£8.29

Source

Analyst x2

Analyst x2

Est @ 18%, capped from 27.26%

Est @ 17%, capped from 27.26%

Est @ 16%, capped from 27.26%

Present Value Discounted @ 8.28%

£3.49

£4.42

£4.81

£5.20

£5.57

Present Value of 5-year Cash Flow (PVCF)

= UK£23m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. 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)

= FCF

2023

× (1 + g) ÷ (r – g) = UK£8.3m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£122m

Present Value of Terminal Value (PVTV)

= TV / (1 + r)

5

= UK£122m ÷ ( 1 + 8.3%)

5

= UK£82m

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£106m. 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 £1.72

. Relative to the current share price of £1.76, the stock is fair value, maybe slightly overvalued at the time of writing.

Story continues

AIM:CPC Intrinsic Value Export January 1st 19

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 City Pub 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:

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. For CPC, there are three pertinent factors you should further examine:

Financial Health

: Does CPC 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 CPC’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 CPC? 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

[email protected]

.

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