How far off is Brinker International (NYSE:EAT) to its intrinsic value? I am going to take a look now by estimating the Future Cash Flows and discounting them to their present value. A discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows to a stock. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
If you are reading this and its not January 2017 then I highly recommend you check out the latest calculation for Brinker International by following the link below. View our latest analysis for Brinker International
I’m 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 perpetual stable growth rate. In the 1st stage we need to estimate the cash flows to the business over the next 5 years, where possible I use analysts estimates but when these aren’t available I have extrapolated the previous Free Cash Flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past 5 years, but capped to a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.
Step by step through the calculation
Please note that the numbers here are in millions apart from the per share values.
5-year cash flow estimate
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (USD, Millions) | $228.56 | $225.30 | $215.46 | $223.04 | $230.89 |
Source | Analyst x3 | Analyst x3 | Analyst x1 | Extrapolated @ (3.52%) | Extrapolated @ (3.52%) |
Present Value Discounted @ 8.35% | $210.94 | $191.92 | $169.39 | $161.83 | $154.62 |
Present value of next 5 years cash flows: $889
The 2nd stage is also known as Terminal Value, this is the cash flows to the business after the 1st stage. The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate of (1.8%).
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $231 × (1 + 1.8%) ÷ (8.4% – 1.8%)
Terminal value based on the Perpetuity Method where growth (g) = 1.8%: $3,560
Present value of terminal value: $2,384
So the total value is the sum of the next 5 years cash flows and the terminal value discounted to today, this is known as the Equity Value.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $889 + $2,384 = $3,272
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.
Value = Total value / Shares Outstanding ($3,272.42 / 49.66)
Value per share: $65.9
Now when we compare the intrinsic value of 65.9 to the current share price of $46.76 we see Brinker International (NYSE:EAT) is a touch undervalued at a 29% discount to what it is available for right now.
The Assumptions
Now 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 Brinker International as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 8.4% and this is based on a Levered Beta of 0.8. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.
Conclusion
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Brinker International in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.