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Is Hilton Food Group plc (LON:HFG) Trading At A 38% Discount?

Key Insights

  • The projected fair value for Hilton Food Group is UK£10.65 based on 2 Stage Free Cash Flow to Equity

  • Current share price of UK£6.60 suggests Hilton Food Group is potentially 38% undervalued

  • Our fair value estimate is 37% higher than Hilton Food Group's analyst price target of UK£7.78

Does the April share price for Hilton Food Group plc (LON:HFG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Hilton Food Group

Step By Step Through The Calculation

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 begin with, we have to get estimates of 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) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (£, Millions)

UK£57.2m

UK£58.8m

UK£60.0m

UK£61.0m

UK£61.9m

UK£62.8m

UK£63.6m

UK£64.4m

UK£65.2m

UK£66.0m

Growth Rate Estimate Source

Analyst x3

Analyst x5

Analyst x3

Est @ 1.65%

Est @ 1.50%

Est @ 1.39%

Est @ 1.32%

Est @ 1.27%

Est @ 1.23%

Est @ 1.21%

Present Value (£, Millions) Discounted @ 7.4%

UK£53.2

UK£51.0

UK£48.5

UK£45.9

UK£43.4

UK£41.0

UK£38.7

UK£36.5

UK£34.4

UK£32.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£425m

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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£66m× (1 + 1.2%) ÷ (7.4%– 1.2%) = UK£1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£1.1b÷ ( 1 + 7.4%)10= UK£528m

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£953m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£6.6, the company appears quite good value at a 38% 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.

dcf
dcf

Important Assumptions

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 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 Hilton Food 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 7.4%, which is based on a levered beta of 0.891. 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 Hilton Food Group

Strength

  • No major strengths identified for HFG.

Weakness

  • Earnings declined over the past year.

  • Interest payments on debt are not well covered.

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

Opportunity

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

  • Trading below our estimate of fair value by more than 20%.

  • Significant insider buying over the past 3 months.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by earnings and cashflows.

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

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. 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 Hilton Food Group, there are three fundamental items you should look at:

  1. Risks: You should be aware of the 4 warning signs for Hilton Food Group (2 are a bit concerning!) we've uncovered before considering an investment in the company.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for HFG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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