Calculating The Intrinsic Value Of RS Group plc (LON:RS1)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, RS Group fair value estimate is UK£7.84

• Current share price of UK£7.72 suggests RS Group is potentially trading close to its fair value

• The UK£10.19 analyst price target for RS1 is 30% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of RS Group plc (LON:RS1) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for RS Group

The Model

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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£208.4m	UK£259.3m	UK£277.4m	UK£290.3m	UK£300.8m	UK£309.5m	UK£316.9m	UK£323.5m	UK£329.3m	UK£334.7m
Growth Rate Estimate Source	Analyst x5	Analyst x6	Analyst x5	Est @ 4.63%	Est @ 3.62%	Est @ 2.90%	Est @ 2.40%	Est @ 2.05%	Est @ 1.81%	Est @ 1.64%
Present Value (£, Millions) Discounted @ 8.9%	UK£191	UK£218	UK£215	UK£206	UK£196	UK£185	UK£174	UK£163	UK£152	UK£142

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.8b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£335m× (1 + 1.2%) ÷ (8.9%– 1.2%) = UK£4.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£4.4b÷ ( 1 + 8.9%)¹⁰= UK£1.9b

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£3.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£7.7, the company appears about fair value at a 1.5% 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

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 RS 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 8.9%, which is based on a levered beta of 1.106. 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 RS Group

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

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

Opportunity

• Annual revenue is forecast to grow faster than the British market.

• Good value based on P/E ratio and estimated fair value.

• Significant insider buying over the past 3 months.

Threat

• Annual earnings are forecast to grow slower than the British market.

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 RS Group, there are three fundamental aspects you should further examine:

1. Financial Health: Does RS1 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.

2. Future Earnings: How does RS1'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.