U.S. markets open in 4 hours 15 minutes
  • S&P Futures

    3,788.25
    +26.00 (+0.69%)
     
  • Dow Futures

    30,884.00
    +164.00 (+0.53%)
     
  • Nasdaq Futures

    12,928.50
    +126.25 (+0.99%)
     
  • Russell 2000 Futures

    2,147.20
    +26.40 (+1.24%)
     
  • Crude Oil

    52.58
    +0.22 (+0.42%)
     
  • Gold

    1,842.40
    +12.50 (+0.68%)
     
  • Silver

    25.42
    +0.55 (+2.23%)
     
  • EUR/USD

    1.2132
    +0.0048 (+0.40%)
     
  • 10-Yr Bond

    1.0970
    0.0000 (0.00%)
     
  • Vix

    22.96
    -0.29 (-1.25%)
     
  • GBP/USD

    1.3621
    +0.0034 (+0.25%)
     
  • USD/JPY

    103.9700
    +0.2830 (+0.27%)
     
  • BTC-USD

    37,188.25
    +746.52 (+2.05%)
     
  • CMC Crypto 200

    733.63
    -1.51 (-0.21%)
     
  • FTSE 100

    6,741.39
    +20.74 (+0.31%)
     
  • Nikkei 225

    28,633.46
    +391.25 (+1.39%)
     

Calculating The Intrinsic Value Of Pact Group Holdings Ltd (ASX:PGH)

Simply Wall St
·6 min read

How far off is Pact Group Holdings Ltd (ASX:PGH) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Pact Group Holdings

The method

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF (A$, Millions)

AU$61.0m

AU$65.5m

AU$68.5m

AU$10.0m

AU$85.0m

AU$85.5m

AU$86.4m

AU$87.5m

AU$88.8m

AU$90.3m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Analyst x2

Analyst x1

Analyst x1

Est @ 0.59%

Est @ 1.02%

Est @ 1.31%

Est @ 1.52%

Est @ 1.67%

Present Value (A$, Millions) Discounted @ 8.2%

AU$56.4

AU$55.9

AU$54.1

AU$7.3

AU$57.3

AU$53.3

AU$49.7

AU$46.6

AU$43.7

AU$41.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$465m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = AU$90m× (1 + 2.0%) ÷ (8.2%– 2.0%) = AU$1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.5b÷ ( 1 + 8.2%)10= AU$676m

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 AU$1.1b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$2.7, the company appears about fair value at a 19% 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
dcf

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Pact Group Holdings 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 8.2%, which is based on a levered beta of 1.184. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Pact Group Holdings, we've put together three pertinent factors you should further research:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Pact Group Holdings , and understanding these should be part of your investment process.

  2. Future Earnings: How does PGH'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

This article by Simply Wall St is general in nature. 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.

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