Stock Analysis

Is There An Opportunity With JB Hi-Fi Limited's (ASX:JBH) 25% Undervaluation?

ASX:JBH
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, JB Hi-Fi fair value estimate is AU$63.45
  • JB Hi-Fi is estimated to be 25% undervalued based on current share price of AU$47.56
  • Analyst price target for JBH is AU$45.91 which is 28% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of JB Hi-Fi Limited (ASX:JBH) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for JB Hi-Fi

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (A$, Millions) AU$475.6m AU$463.2m AU$470.3m AU$499.4m AU$399.0m AU$391.5m AU$388.8m AU$389.4m AU$392.2m AU$396.6m
Growth Rate Estimate Source Analyst x5 Analyst x5 Analyst x5 Analyst x2 Analyst x1 Est @ -1.88% Est @ -0.69% Est @ 0.14% Est @ 0.72% Est @ 1.13%
Present Value (A$, Millions) Discounted @ 7.2% AU$444 AU$403 AU$382 AU$378 AU$282 AU$258 AU$239 AU$223 AU$209 AU$198

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$3.0b

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 (2.1%) 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 7.2%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$397m× (1 + 2.1%) ÷ (7.2%– 2.1%) = AU$7.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$7.9b÷ ( 1 + 7.2%)10= AU$3.9b

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$6.9b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$47.6, the company appears a touch undervalued at a 25% 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.

dcf
ASX:JBH Discounted Cash Flow November 15th 2023

The Assumptions

Now 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 JB Hi-Fi 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 7.2%, which is based on a levered beta of 1.028. 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 JB Hi-Fi

Strength
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.
Opportunity
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

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. Why is the intrinsic value higher than the current share price? For JB Hi-Fi, there are three important aspects you should look at:

  1. Risks: Take risks, for example - JB Hi-Fi has 3 warning signs (and 1 which is significant) we think you should know about.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for JBH'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. 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 JB Hi-Fi 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.