Bega Cheese Limited's (ASX:BGA) Intrinsic Value Is Potentially 30% Above Its Share Price
- Bega Cheese's estimated fair value is AU$4.12 based on 2 Stage Free Cash Flow to Equity
- Bega Cheese is estimated to be 23% undervalued based on current share price of AU$3.17
- Analyst price target for BGA is AU$3.82 which is 7.2% below our fair value estimate
In this article we are going to estimate the intrinsic value of Bega Cheese Limited (ASX:BGA) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Bega Cheese
Crunching The Numbers
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF (A$, Millions)||AU$32.4m||AU$94.9m||AU$92.3m||AU$69.2m||AU$76.0m||AU$71.3m||AU$68.7m||AU$67.3m||AU$66.7m||AU$66.7m|
|Growth Rate Estimate Source||Analyst x2||Analyst x3||Analyst x3||Analyst x1||Analyst x1||Est @ -6.15%||Est @ -3.73%||Est @ -2.03%||Est @ -0.84%||Est @ -0.01%|
|Present Value (A$, Millions) Discounted @ 6.7%||AU$30.3||AU$83.4||AU$76.0||AU$53.4||AU$55.0||AU$48.4||AU$43.7||AU$40.1||AU$37.3||AU$34.9|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$502m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$67m× (1 + 1.9%) ÷ (6.7%– 1.9%) = AU$1.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.4b÷ ( 1 + 6.7%)10= AU$749m
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$1.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$3.2, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. 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.
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 Bega Cheese 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 6.7%, which is based on a levered beta of 0.800. 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 Bega Cheese
- Debt is well covered by cash flow.
- Earnings declined over the past year.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Food market.
- Annual earnings are forecast to grow faster than the Australian market.
- Good value based on P/S ratio and estimated fair value.
- Dividends are not covered by earnings.
- Annual revenue is forecast to grow slower than the Australian market.
Although the valuation of a company is important, it is only one of many factors that you need to assess 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Bega Cheese, we've compiled three further factors you should further research:
- Risks: We feel that you should assess the 3 warning signs for Bega Cheese we've flagged before making an investment in the company.
- Future Earnings: How does BGA'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.
- 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.
Valuation is complex, but we're helping make it simple.
Find out whether Bega Cheese 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
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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.
Bega Cheese Limited receives, processes, manufactures, and distributes dairy and other food-related products in Australia.
Excellent balance sheet, good value and pays a dividend.