How far off is DS Smith Plc (LON:SMDS) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for DS Smith by following the link below.
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Is SMDS fairly valued?
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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF (£, Millions)||£366.83||£419.01||£458.09||£503.28||£552.94|
|Source||Analyst x7||Analyst x7||Analyst x7||Est @ 9.87%||Est @ 9.87%|
|Present Value Discounted @ 10.94%||£330.65||£340.44||£335.47||£332.22||£329.00|
Present Value of 5-year Cash Flow (PVCF)= UK£1.7b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.9%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = UK£553m × (1 + 1.2%) ÷ (10.9% – 1.2%) = UK£5.8b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£5.8b ÷ ( 1 + 10.9%)5 = UK£3.4b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£5.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of £3.72. Compared to the current share price of £3.36, the stock is about right, perhaps slightly undervalued at a 9.9% discount to what it is available for right now.
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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at DS Smith as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.9%, which is based on a levered beta of 1.107. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For SMDS, there are three fundamental aspects you should further research:
- Financial Health: Does SMDS 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.
- Future Earnings: How does SMDS’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of SMDS? 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 does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.