A Look At The Intrinsic Value Of Royal Mail plc (LON:RMG)
I am going to run you through how I calculated the intrinsic value of Royal Mail plc (LON:RMG) by taking the expected future cash flows and discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not September 2018 then I highly recommend you check out the latest calculation for Royal Mail by following the link below.
See our latest analysis for Royal Mail
Crunching the numbers
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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (£, Millions) | £325.95 | £407.47 | £386.53 | £404.07 | £470.25 |
Source | Analyst x8 | Analyst x10 | Analyst x10 | Analyst x3 | Analyst x2 |
Present Value Discounted @ 9.3% | £298.22 | £341.08 | £296.02 | £283.12 | £301.46 |
Present Value of 5-year Cash Flow (PVCF)= UK£1.52b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (1.4%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£470.3m × (1 + 1.4%) ÷ (9.3% – 1.4%) = UK£6.03b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£6.03b ÷ ( 1 + 9.3%)5 = UK£3.87b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£5.39b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of £5.39. Compared to the current share price of £4.67, the stock is about right, perhaps slightly undervalued at a 13.3% discount to what it is available for right now.
Important assumptions
I’d like to 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Royal Mail as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.3%, which is based on a levered beta of 0.919. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For RMG, there are three pertinent aspects you should further examine:
Financial Health: Does RMG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does RMG’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: Are there other high quality stocks you could be holding instead of RMG? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the LON every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
