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Estimating The Fair Value Of Regional Express Holdings Limited (ASX:REX)

Simply Wall St

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In this article we are going to estimate the intrinsic value of Regional Express Holdings Limited (ASX:REX) by estimating the company's future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Regional Express Holdings

The calculation

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
Levered FCF (A$, Millions) A$11.55 A$10.10 A$9.28 A$8.82 A$8.57 A$8.46 A$8.45 A$8.50 A$8.59 A$8.71
Growth Rate Estimate Source Est @ -18.96% Est @ -12.58% Est @ -8.11% Est @ -4.98% Est @ -2.79% Est @ -1.26% Est @ -0.19% Est @ 0.56% Est @ 1.09% Est @ 1.45%
Present Value (A$, Millions) Discounted @ 7.79% A$10.72 A$8.69 A$7.41 A$6.53 A$5.89 A$5.40 A$5.00 A$4.66 A$4.37 A$4.11

Present Value of 10-year Cash Flow (PVCF)= A$62.78m

"Est" = FCF growth rate estimated by Simply Wall St

After calculating the present value of future cash flows in the intial 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 10-year government bond rate of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = AU$8.7m × (1 + 2.3%) ÷ (7.8% – 2.3%) = AU$163m

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = A$AU$163m ÷ ( 1 + 7.8%)10 = A$76.76m

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 A$139.54m. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of A$1.28. Relative to the current share price of A$1.4, the company appears around fair value at the time of writing. 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.

ASX:REX Intrinsic value, June 11th 2019

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Regional Express 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 7.8%, which is based on a levered beta of 0.920. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Regional Express Holdings, There are three additional aspects you should further examine:

  1. Financial Health: Does REX 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. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of REX? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every AU stock every day, so if you want to find the intrinsic value of any other stock just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.