Does the share price for Rolls-Royce Holdings plc (LSE:RR.) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value using the discounted cash flow (DCF) method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Also note that this article was written in December 2017 so be sure check the latest calculation for Rolls-Royce Holdings here.
What’s the value?
I use what is known as the 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To start off, I use the analyst consensus estimates of RR.’s levered free cash flow (FCF) over the next five years and discounted these values at the rate of 8.3%. This resulted in a present value of 5-year cash flow of £2,528.8M. Keen to know how I arrived at this number? Read our detailed analysis here.
In the visual above, we see how how RR.’s top and bottom lines are expected to move going forward, which should give you some color on RR.’s outlook. Next, I calculate the terminal value, which is the business’s cash flow after the first stage. I’ve decided to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is £9,661.7M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is £12,190.5M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of £6.63, which, compared to the current share price of £8.595, we see that Rolls-Royce Holdings is fair value, maybe slightly overvalued and not available at a discount at this time.
Next Steps:
Whilst important, DCF calculation 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 RR., I’ve compiled three pertinent factors you should further examine:
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the LSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass 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.