Stock Analysis

Endeavour Group Limited's (ASX:EDV) Intrinsic Value Is Potentially 49% Above Its Share Price

ASX:EDV
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Key Insights

  • Endeavour Group's estimated fair value is AU$9.45 based on 2 Stage Free Cash Flow to Equity
  • Endeavour Group is estimated to be 33% undervalued based on current share price of AU$6.35
  • Our fair value estimate is 37% higher than Endeavour Group's analyst price target of AU$6.91

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Endeavour Group Limited (ASX:EDV) as an investment opportunity by projecting its future cash flows and then 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Endeavour Group

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. To begin with, we have to get estimates of the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (A$, Millions) AU$487.4m AU$600.7m AU$663.3m AU$607.3m AU$850.5m AU$916.2m AU$971.1m AU$1.02b AU$1.06b AU$1.09b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Analyst x2 Analyst x1 Est @ 7.73% Est @ 6.00% Est @ 4.79% Est @ 3.94% Est @ 3.34%
Present Value (A$, Millions) Discounted @ 7.0% AU$456 AU$525 AU$542 AU$464 AU$608 AU$612 AU$607 AU$594 AU$577 AU$558

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$5.5b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$1.1b× (1 + 2.0%) ÷ (7.0%– 2.0%) = AU$22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$22b÷ ( 1 + 7.0%)10= AU$11b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$17b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$6.4, the company appears quite good value at a 33% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
ASX:EDV Discounted Cash Flow May 9th 2023

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Endeavour 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 7.0%, which is based on a levered beta of 0.841. 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.

SWOT Analysis for Endeavour Group

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings growth over the past year underperformed the Consumer Retailing industry.
  • Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Dividends are not covered by cash flow.
  • Annual earnings are forecast to grow slower than the Australian market.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Endeavour Group, we've put together three essential elements you should consider:

  1. Risks: We feel that you should assess the 1 warning sign for Endeavour Group we've flagged before making an investment in the company.
  2. Future Earnings: How does EDV's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Endeavour Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.