A Look At The Fair Value Of SSP Group plc (LON:SSPG)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, SSP Group fair value estimate is UK£2.33

• SSP Group's UK£2.73 share price indicates it is trading at similar levels as its fair value estimate

• The UK£3.19 analyst price target for SSPG is 37% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of SSP Group plc (LON:SSPG) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

Check out our latest analysis for SSP Group

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	-UK£87.8m	UK£77.5m	UK£127.1m	UK£166.0m	UK£197.5m	UK£220.3m	UK£238.9m	UK£253.9m	UK£266.0m	UK£275.9m
Growth Rate Estimate Source	Analyst x6	Analyst x8	Analyst x8	Analyst x3	Analyst x2	Est @ 11.54%	Est @ 8.45%	Est @ 6.29%	Est @ 4.77%	Est @ 3.71%
Present Value (£, Millions) Discounted @ 11%	-UK£79.1	UK£62.9	UK£93.0	UK£109	UK£117	UK£118	UK£115	UK£110	UK£104	UK£97.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£848m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£276m× (1 + 1.2%) ÷ (11%– 1.2%) = UK£2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£2.9b÷ ( 1 + 11%)¹⁰= UK£1.0b

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£1.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.7, the company appears around fair value at the time of writing. 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

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 SSP 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 11%, which is based on a levered beta of 1.399. 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 SSP Group

Strength

• Debt is well covered by cash flow.

Weakness

• Interest payments on debt are not well covered.

Opportunity

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

• Good value based on P/S ratio compared to estimated Fair P/S ratio.

Threat

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

Next Steps:

Whilst important, the DCF calculation 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. 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 SSP Group, we've put together three essential elements you should explore:

1. Risks: For example, we've discovered 2 warning signs for SSP Group (1 doesn't sit too well with us!) that you should be aware of before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SSPG'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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