Calculating The Fair Value Of Fuller, Smith & Turner P.L.C. (LON:FSTA)

Key Insights

• The projected fair value for Fuller Smith & Turner is UK£5.69 based on 2 Stage Free Cash Flow to Equity

• Current share price of UK£5.86 suggests Fuller Smith & Turner is potentially trading close to its fair value

• Our fair value estimate is 17% lower than Fuller Smith & Turner's analyst price target of UK£6.89

Does the June share price for Fuller, Smith & Turner P.L.C. (LON:FSTA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's 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 would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Fuller Smith & Turner

The Calculation

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 begin with, we have to get estimates of 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£14.6m	UK£17.9m	UK£18.8m	UK£26.2m	UK£31.1m	UK£35.2m	UK£38.7m	UK£41.5m	UK£43.7m	UK£45.5m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x1	Est @ 18.62%	Est @ 13.41%	Est @ 9.76%	Est @ 7.20%	Est @ 5.41%	Est @ 4.16%
Present Value (£, Millions) Discounted @ 11%	UK£13.2	UK£14.6	UK£13.9	UK£17.5	UK£18.7	UK£19.2	UK£19.0	UK£18.4	UK£17.5	UK£16.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£168m

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 5-year average of the 10-year government bond yield of 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£46m× (1 + 1.2%) ÷ (11%– 1.2%) = UK£489m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£489m÷ ( 1 + 11%)¹⁰= UK£177m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£346m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£5.9, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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 these result, have a go at the calculation yourself and play with the 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 Fuller Smith & Turner 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 11%, which is based on a levered beta of 1.353. 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 Fuller Smith & Turner

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Debt is well covered by cash flow.

Weakness

• Earnings growth over the past year underperformed the Hospitality industry.

• Interest payments on debt are not well covered.

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

• Current share price is above our estimate of fair value.

Opportunity

• FSTA's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

• Dividends are not covered by earnings.

• Annual earnings have declined over the past 5 years.

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. For Fuller Smith & Turner, we've put together three additional elements you should further examine:

1. Risks: You should be aware of the 2 warning signs for Fuller Smith & Turner (1 doesn't sit too well with us!) we've uncovered before considering an investment in the company.

2. Future Earnings: How does FSTA'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 LSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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