Ibstock plc's (LON:IBST) Intrinsic Value Is Potentially 66% Above Its Share Price
Does the September share price for Ibstock plc (LON:IBST) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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 Ibstock
The model
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 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF (£, Millions) | UK£43.7m | UK£52.9m | UK£59.5m | UK£65.0m | UK£69.4m | UK£72.9m | UK£75.8m | UK£78.2m | UK£80.1m | UK£81.9m |
Growth Rate Estimate Source | Analyst x6 | Analyst x5 | Est @ 12.57% | Est @ 9.16% | Est @ 6.78% | Est @ 5.11% | Est @ 3.94% | Est @ 3.13% | Est @ 2.56% | Est @ 2.15% |
Present Value (£, Millions) Discounted @ 7.8% | UK£40.5 | UK£45.5 | UK£47.5 | UK£48.1 | UK£47.6 | UK£46.4 | UK£44.8 | UK£42.8 | UK£40.7 | UK£38.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£442m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 (1.2%) 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 7.8%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = UK£82m× (1 + 1.2%) ÷ (7.8%– 1.2%) = UK£1.3b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£1.3b÷ ( 1 + 7.8%)10= UK£593m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£1.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.5, the company appears quite undervalued at a 40% discount to where the stock price trades currently. 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.
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 Ibstock 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 0.952. 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:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. What is the reason for the share price sitting below the intrinsic value? For Ibstock, we've put together three fundamental items you should assess:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Ibstock , and understanding it should be part of your investment process.
Future Earnings: How does IBST'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: 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.
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. 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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