In this article, we’ll estimate the intrinsic value of Breville Group Limited (ASX: BRG) by projecting its future cash flows and then discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it might seem quite complex.
There are many ways that businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
See our latest analysis for Breville Group
The method
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth, and the second stage is lower growth stage. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
| 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
| Leverage FCF (A $, Millions) | AU $ 61.8 million | A $ 123.3 million | AU $ 144.4 million | 159.8 million Australian dollars | A $ 172.7 million | A $ 183.4 million | 192.3 million Australian dollars | AU $ 200.0 million | 206.7 million Australian dollars | 212.7 million Australian dollars |
| Source of estimated growth rate | Analyst x1 | Analyst x1 | Analyst x1 | Is 10.69% | Est @ 8.04% | Is 6.19% | Est @ 4.89% | East @ 3.98% | East @ 3.34% | Is 2.9% |
| Present value (A $, Millions) discounted at 6.9% | A $ 57.8 | 108 AUD | A $ 118 | A $ 122 | A $ 124 | AU $ 123 | AU $ 120 | A $ 117 | AU $ 113 | AU $ 109 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = AU $ 1.1 billion
The second stage is also known as terminal value, it is the cash flow of the business after 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 used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 6.9%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU $ 213 million × (1 + 1.9%) ÷ (6.9% – 1.9%) = AU $ 4.3 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= 4.3 billion Australian dollars ÷ (1 + 6.9%)ten= 2.2 billion Australian dollars
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is AU $ 3.3 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of AU $ 31.0, the company looks reasonably expensive at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Breville Group 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 takes debt into account. In this calculation, we used 6.9%, which is based on a leveraged beta of 1.155. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Move on :
While a business valuation is important, ideally it won’t be the only analysis that you look at for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Why is intrinsic value lower than the current share price? For Breville Group, we’ve put together three relevant things that you should take a closer look at:
- Financial health: Does BRG 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 benefits: How does BRG’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each ASX share. If you want to find the calculation for other actions, just search here.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.