Is Group 1 Automotive, Inc. (NYSE:GPI) Trading At A 39% Discount?
Does the June share price for Group 1 Automotive, Inc. (NYSE:GPI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. There's really not all that much to it, even though it might appear quite complex.
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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Group 1 Automotive
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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF ($, Millions) | US$487.0m | US$561.3m | US$170.2m | US$650.1m | US$474.9m | US$382.2m | US$332.2m | US$303.7m | US$287.3m | US$278.0m |
Growth Rate Estimate Source | Analyst x1 | Analyst x2 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ -19.5% | Est @ -13.08% | Est @ -8.58% | Est @ -5.43% | Est @ -3.22% |
Present Value ($, Millions) Discounted @ 8.3% | US$450 | US$478 | US$134 | US$472 | US$318 | US$237 | US$190 | US$160 | US$140 | US$125 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.7b
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 (1.9%) 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 8.3%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$278m× (1 + 1.9%) ÷ (8.3%– 1.9%) = US$4.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.4b÷ ( 1 + 8.3%)10= US$2.0b
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 US$4.7b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$179, the company appears quite undervalued at a 39% 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.
Important 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. 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 Group 1 Automotive 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 8.3%, which is based on a levered beta of 1.511. 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.
Moving On:
Although the valuation of a company is important, 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Group 1 Automotive, we've put together three important elements you should assess:
Risks: For example, we've discovered 3 warning signs for Group 1 Automotive (1 can't be ignored!) that you should be aware of before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GPI's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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.
