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Is There An Opportunity With George Weston Limited’s (TSE:WN) 44.37% Undervaluation?

Dane Simmons

In this article I am going to calculate the intrinsic value of George Weston Limited (TSE:WN) by estimating the company’s future cash flows and discounting them to their present 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. Please also note that this article was written in August 2018 so be sure check out the updated calculation by following the link below.

See our latest analysis for George Weston

Step by step through 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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow forecast

2018 2019 2020 2021 2022
Levered FCF (CA$, Millions) CA$1.16k CA$1.70k CA$1.82k CA$1.95k CA$2.09k
Source Analyst x2 Analyst x2 Est @ 7.08% Est @ 7.08% Est @ 7.08%
Present Value Discounted @ 10.03% CA$1.06k CA$1.40k CA$1.37k CA$1.33k CA$1.29k

Present Value of 5-year Cash Flow (PVCF)= CA$6.45b

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 an annual growth rate equal to the 10-year government bond rate of 2.3%. We discount this to today’s value at a cost of equity of 10%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$2.09b × (1 + 2.3%) ÷ (10% – 2.3%) = CA$27.78b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$27.78b ÷ ( 1 + 10%)5 = CA$17.22b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is CA$23.67b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of CA$184.94. Relative to the current share price of CA$102.88, the stock is quite undervalued at a 44.4% discount to what it is available for right now.

TSX:WN Intrinsic Value Export August 24th 18

The 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. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at George Weston 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 10%, which is based on a levered beta of 1.004. 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. What is the reason for the share price to differ from the intrinsic value? For WN, I’ve put together three pertinent factors you should further examine:

  1. Financial Health: Does WN 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.
  2. Future Earnings: How does WN’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of WN? 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 TSE 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.