Estimating The Fair Value Of Breville Group Limited (ASX:BRG)

Key Insights

• The projected fair value for Breville Group is AU$26.54 based on 2 Stage Free Cash Flow to Equity

• With AU$21.60 share price, Breville Group appears to be trading close to its estimated fair value

• Analyst price target for BRG is AU$23.63 which is 11% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Breville Group Limited (ASX:BRG) as an investment opportunity by projecting its future cash flows and then discounting them 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Breville Group

The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$195.5m	AU$127.1m	AU$136.7m	AU$152.2m	AU$205.0m	AU$229.3m	AU$249.7m	AU$266.7m	AU$281.1m	AU$293.3m
Growth Rate Estimate Source	Analyst x5	Analyst x6	Analyst x5	Analyst x3	Analyst x1	Est @ 11.84%	Est @ 8.89%	Est @ 6.83%	Est @ 5.38%	Est @ 4.37%
Present Value (A$, Millions) Discounted @ 7.8%	AU$181	AU$109	AU$109	AU$113	AU$141	AU$146	AU$147	AU$146	AU$143	AU$138

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.4b

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 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$293m× (1 + 2.0%) ÷ (7.8%– 2.0%) = AU$5.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$5.2b÷ ( 1 + 7.8%)¹⁰= AU$2.4b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$3.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$21.6, the company appears about fair value at a 19% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Breville 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 7.8%, which is based on a levered beta of 1.160. 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 Breville Group

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

Weakness

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

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

Opportunity

• Annual earnings are forecast to grow faster than the Australian market.

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

Threat

• Revenue is forecast to grow slower than 20% per year.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 Breville Group, we've put together three essential aspects you should consider:

1. Financial Health: Does BRG 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 BRG'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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.