Calculating The Intrinsic Value Of Ardent Leisure Group Limited (ASX:ALG)

Key Insights

• The projected fair value for Ardent Leisure Group is AU$0.48 based on 2 Stage Free Cash Flow to Equity
• Current share price of AU$0.53 suggests Ardent Leisure Group is potentially trading close to its fair value
• Analyst price target for ALG is AU$0.63, which is 31% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Ardent Leisure Group Limited (ASX:ALG) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Ardent Leisure Group

The Method

We're 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 a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	-AU$22.6m	-AU$8.60m	AU$11.0m	AU$14.0m	AU$16.2m	AU$18.2m	AU$19.8m	AU$21.1m	AU$22.3m	AU$23.2m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 16.05%	Est @ 11.83%	Est @ 8.87%	Est @ 6.79%	Est @ 5.34%	Est @ 4.33%
Present Value (A$, Millions) Discounted @ 8.1%	-AU$20.9	-AU$7.4	AU$8.7	AU$10.2	AU$11.0	AU$11.4	AU$11.4	AU$11.3	AU$11.0	AU$10.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$57m

The second stage is also known as Terminal Value, this is the business's cash flow 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 have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$23m× (1 + 2.0%) ÷ (8.1%– 2.0%) = AU$382m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$382m÷ ( 1 + 8.1%)¹⁰= AU$175m

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$232m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Ardent Leisure 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 8.1%, which is based on a levered beta of 1.042. 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 Ardent Leisure 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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Ardent Leisure Group, we've put together three additional aspects you should assess:

1. Financial Health: Does ALG 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.
2. Future Earnings: How does ALG'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. 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.

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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.