Are Breville Group Limited (ASX:BRG) Investors Paying Above The Intrinsic Value?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Breville Group fair value estimate is AU$25.62
• Breville Group's AU$31.45 share price signals that it might be 23% overvalued
• Our fair value estimate is 27% lower than Breville Group's analyst price target of AU$35.21

How far off is Breville Group Limited (ASX:BRG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (A$, Millions)	AU$132.9m	AU$131.3m	AU$149.5m	AU$191.0m	AU$214.0m	AU$231.4m	AU$246.5m	AU$259.8m	AU$271.7m	AU$282.7m
Growth Rate Estimate Source	Analyst x4	Analyst x5	Analyst x3	Analyst x1	Analyst x1	Est @ 8.14%	Est @ 6.52%	Est @ 5.39%	Est @ 4.59%	Est @ 4.04%
Present Value (A$, Millions) Discounted @ 8.3%	AU$123	AU$112	AU$118	AU$139	AU$144	AU$144	AU$141	AU$138	AU$133	AU$128

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$283m× (1 + 2.7%) ÷ (8.3%– 2.7%) = AU$5.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$5.2b÷ ( 1 + 8.3%)¹⁰= AU$2.4b

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 AU$3.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$31.5, the company appears slightly overvalued at the time of writing. 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 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 accounts for debt. In this calculation we've used 8.3%, which is based on a levered beta of 1.278. 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.

See our latest analysis for Breville Group

SWOT Analysis for Breville Group

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Breville Group, we've put together three additional elements you should assess:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Breville Group .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BRG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks 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.