Estimating The Intrinsic Value Of Topps Tiles Plc (LON:TPT)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Topps Tiles fair value estimate is UK£0.44

• Current share price of UK£0.50 suggests Topps Tiles is potentially trading close to its fair value

• The UK£0.80 analyst price target for TPT is 80% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Topps Tiles Plc (LON:TPT) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Topps Tiles

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£15.9m	UK£10.2m	UK£13.4m	UK£10.1m	UK£8.43m	UK£7.48m	UK£6.93m	UK£6.60m	UK£6.41m	UK£6.31m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ -24.50%	Est @ -16.70%	Est @ -11.23%	Est @ -7.41%	Est @ -4.73%	Est @ -2.85%	Est @ -1.54%
Present Value (£, Millions) Discounted @ 10%	UK£14.4	UK£8.4	UK£10.0	UK£6.8	UK£5.1	UK£4.1	UK£3.5	UK£3.0	UK£2.6	UK£2.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£60m

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 (1.5%) 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 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£6.3m× (1 + 1.5%) ÷ (10%– 1.5%) = UK£72m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£72m÷ ( 1 + 10%)¹⁰= UK£27m

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£87m. 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£0.5, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Topps Tiles 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 10%, which is based on a levered beta of 1.497. 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 Topps Tiles

Strength

• Currently debt free.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

Threat

• Dividends are not covered by earnings.

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

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Topps Tiles, we've put together three essential factors you should explore:

1. Risks: Every company has them, and we've spotted 2 warning signs for Topps Tiles you should know about.

2. Future Earnings: How does TPT'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. Simply Wall St updates its DCF calculation for every British 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.