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A Look At The Fair Value Of Domino's Pizza Enterprises Limited (ASX:DMP)

Key Insights

  • The projected fair value for Domino's Pizza Enterprises is AU$50.03 based on 2 Stage Free Cash Flow to Equity

  • With AU$54.09 share price, Domino's Pizza Enterprises appears to be trading close to its estimated fair value

  • Analyst price target for DMP is AU$56.32, which is 13% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Domino's Pizza Enterprises Limited (ASX:DMP) as an investment opportunity 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Domino's Pizza Enterprises

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.

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

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$171.3m

AU$202.1m

AU$260.8m

AU$282.0m

AU$302.1m

AU$317.4m

AU$330.6m

AU$342.3m

AU$352.9m

AU$362.8m

Growth Rate Estimate Source

Analyst x6

Analyst x6

Analyst x6

Analyst x3

Analyst x2

Est @ 5.06%

Est @ 4.16%

Est @ 3.54%

Est @ 3.10%

Est @ 2.79%

Present Value (A$, Millions) Discounted @ 8.3%

AU$158

AU$172

AU$205

AU$205

AU$202

AU$196

AU$189

AU$180

AU$172

AU$163

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.8b

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$363m× (1 + 2.1%) ÷ (8.3%– 2.1%) = AU$5.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$5.9b÷ ( 1 + 8.3%)10= AU$2.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$4.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$54.1, 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
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 Domino's Pizza Enterprises 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 1.253. 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 Domino's Pizza Enterprises

Strength

  • Debt is well covered by earnings and cashflows.

Weakness

  • Earnings declined over the past year.

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

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

Opportunity

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

Threat

  • Revenue is forecast to grow slower than 20% per year.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 Domino's Pizza Enterprises, we've compiled three further items you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Domino's Pizza Enterprises , and understanding them should be part of your investment process.

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