Stock Analysis

# Calculating The Intrinsic Value Of Reef Casino Trust (ASX:RCT)

•  Updated

In this article we are going to estimate the intrinsic value of Reef Casino Trust (ASX:RCT) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

Check out our latest analysis for Reef Casino Trust

### 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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, 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

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (A\$, Millions) AU\$5.17m AU\$4.44m AU\$4.03m AU\$3.79m AU\$3.66m AU\$3.59m AU\$3.57m AU\$3.57m AU\$3.59m AU\$3.63m Growth Rate Estimate Source Est @ -20.97% Est @ -14.07% Est @ -9.25% Est @ -5.87% Est @ -3.51% Est @ -1.85% Est @ -0.69% Est @ 0.12% Est @ 0.69% Est @ 1.08% Present Value (A\$, Millions) Discounted @ 8.0% AU\$4.8 AU\$3.8 AU\$3.2 AU\$2.8 AU\$2.5 AU\$2.3 AU\$2.1 AU\$1.9 AU\$1.8 AU\$1.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU\$26m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 8.0%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = AU\$3.6m× (1 + 2.0%) ÷ (8.0%– 2.0%) = AU\$62m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU\$62m÷ ( 1 + 8.0%)10= AU\$29m

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\$55m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU\$2.6, the company appears around fair value at the time of writing. 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.

### 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. 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 Reef Casino Trust 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 8.0%, which is based on a levered beta of 1.137. 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.

### Next Steps:

Although the valuation of a company is important, 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Reef Casino Trust, we've put together three important aspects you should further research:

1. Risks: You should be aware of the 5 warning signs for Reef Casino Trust (2 are potentially serious!) we've uncovered before considering an investment in the company.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

If you’re looking to trade Reef Casino Trust, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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

Find out whether Reef Casino Trust 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.

View the Free Analysis