Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of The City Pub Group plc (LON:CPC) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for City Pub Group by following the link below.
View our latest analysis for City Pub Group
Crunching the numbers
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. 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. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF (£, Millions) | £3.77 | £5.18 | £6.11 | £7.15 | £8.29 |
| Source | Analyst x2 | Analyst x2 | Est @ 18%, capped from 27.26% | Est @ 17%, capped from 27.26% | Est @ 16%, capped from 27.26% |
| Present Value Discounted @ 8.28% | £3.49 | £4.42 | £4.81 | £5.20 | £5.57 |
Present Value of 5-year Cash Flow (PVCF)= UK£23m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond 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 1.4%. We discount this to today’s value at a cost of equity of 8.3%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = UK£8.3m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£122m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£122m ÷ ( 1 + 8.3%)5 = UK£82m
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 UK£106m. 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 £1.72. Relative to the current share price of £1.76, the stock is fair value, maybe slightly overvalued at the time of writing.