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Premium Brands Holdings Corporation (TSE:PBH) Shares Could Be 44% Below Their Intrinsic Value Estimate

Key Insights

  • Premium Brands Holdings' estimated fair value is CA$164 based on 2 Stage Free Cash Flow to Equity

  • Premium Brands Holdings' CA$91.90 share price signals that it might be 44% undervalued

  • Analyst price target for PBH is CA$119 which is 28% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Premium Brands Holdings Corporation (TSE:PBH) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Premium Brands Holdings

What's The Estimated Valuation?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (CA$, Millions)

CA$176.9m

CA$277.3m

CA$291.9m

CA$304.4m

CA$315.3m

CA$325.0m

CA$333.9m

CA$342.3m

CA$350.2m

CA$358.0m

Growth Rate Estimate Source

Analyst x3

Analyst x2

Est @ 5.29%

Est @ 4.28%

Est @ 3.58%

Est @ 3.08%

Est @ 2.74%

Est @ 2.50%

Est @ 2.33%

Est @ 2.21%

Present Value (CA$, Millions) Discounted @ 6.0%

CA$167

CA$247

CA$245

CA$242

CA$236

CA$230

CA$223

CA$215

CA$208

CA$201

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$2.2b

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 (1.9%) 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 6.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$358m× (1 + 1.9%) ÷ (6.0%– 1.9%) = CA$9.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$9.1b÷ ( 1 + 6.0%)10= CA$5.1b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CA$7.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CA$91.9, the company appears quite good value at a 44% 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.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Premium Brands Holdings 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 6.0%, which is based on a levered beta of 0.805. 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 Premium Brands Holdings

Strength

  • Debt is well covered by cash flow.

Weakness

  • Earnings declined over the past year.

  • Interest payments on debt are not well covered.

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

Opportunity

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

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Dividends are not covered by earnings and cashflows.

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

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. What is the reason for the share price sitting below the intrinsic value? For Premium Brands Holdings, we've put together three fundamental aspects you should assess:

  1. Risks: For example, we've discovered 3 warning signs for Premium Brands Holdings (2 are a bit concerning!) that you should be aware of before investing here.

  2. Future Earnings: How does PBH'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 Canadian 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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