Briscoe Group Limited (NZSE:BGP) Shares Could Be 27% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Briscoe Group is NZ$6.40 based on 2 Stage Free Cash Flow to Equity

• Current share price of NZ$4.68 suggests Briscoe Group is potentially 27% undervalued

• Industry average discount to fair value of 40% suggests Briscoe Group's peers are currently trading at a higher discount

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Briscoe Group Limited (NZSE:BGP) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Briscoe Group

What's The Estimated Valuation?

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. To start off with, we need to estimate the next ten years of cash flows. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NZ$, Millions)	NZ$81.9m	NZ$88.9m	NZ$86.7m	NZ$85.9m	NZ$85.9m	NZ$86.6m	NZ$87.6m	NZ$89.0m	NZ$90.5m	NZ$92.3m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -0.92%	Est @ 0.05%	Est @ 0.73%	Est @ 1.20%	Est @ 1.53%	Est @ 1.77%	Est @ 1.93%
Present Value (NZ$, Millions) Discounted @ 7.7%	NZ$76.0	NZ$76.6	NZ$69.4	NZ$63.8	NZ$59.3	NZ$55.5	NZ$52.1	NZ$49.1	NZ$46.4	NZ$43.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$592m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$92m× (1 + 2.3%) ÷ (7.7%– 2.3%) = NZ$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$1.7b÷ ( 1 + 7.7%)¹⁰= NZ$833m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$1.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$4.7, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Briscoe Group 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 7.7%, which is based on a levered beta of 1.079. 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.

SWOT Analysis for Briscoe Group

Strength

• Currently debt free.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• No apparent threats visible for BGP.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Briscoe Group, we've compiled three additional items you should assess:

1. Risks: Take risks, for example - Briscoe Group has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

2. Future Earnings: How does BGP'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.

3. 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 NZSE every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.