A Look At The Fair Value Of Telstra Group Limited (ASX:TLS)
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Telstra Group fair value estimate is AU$3.73
- Current share price of AU$3.92 suggests Telstra Group is potentially trading close to its fair value
- Analyst price target for TLS is AU$4.29, which is 15% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Telstra Group Limited (ASX:TLS) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Telstra Group
The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (A$, Millions) | AU$2.85b | AU$3.05b | AU$3.23b | AU$3.39b | AU$1.76b | AU$1.61b | AU$1.52b | AU$1.48b | AU$1.46b | AU$1.46b |
Growth Rate Estimate Source | Analyst x6 | Analyst x7 | Analyst x6 | Analyst x2 | Analyst x1 | Est @ -8.40% | Est @ -5.16% | Est @ -2.89% | Est @ -1.30% | Est @ -0.19% |
Present Value (A$, Millions) Discounted @ 5.7% | AU$2.7k | AU$2.7k | AU$2.7k | AU$2.7k | AU$1.3k | AU$1.2k | AU$1.0k | AU$950 | AU$887 | AU$837 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$17b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 5.7%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$1.5b× (1 + 2.4%) ÷ (5.7%– 2.4%) = AU$45b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$45b÷ ( 1 + 5.7%)10= AU$26b
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$43b. 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$3.9, 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Telstra 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 5.7%, 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 Telstra Group
- Debt is well covered by earnings and cashflows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Telecom market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio compared to estimated Fair P/E ratio.
- Dividends are not covered by earnings and cashflows.
- Annual earnings are forecast to grow slower than the Australian market.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Telstra Group, we've compiled three important factors you should assess:
- Risks: For instance, we've identified 3 warning signs for Telstra Group (1 shouldn't be ignored) you should be aware of.
- Future Earnings: How does TLS'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. 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 here to simplify it.
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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.
About ASX:TLS
Telstra Group
Engages in the provision of telecommunications and information services to businesses, government, and individuals in Australia and internationally.
Mediocre balance sheet low.