Calculating The Intrinsic Value Of Qantas Airways Limited (ASX:QAN)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Qantas Airways fair value estimate is AU$8.98
• Qantas Airways' AU$8.86 share price indicates it is trading at similar levels as its fair value estimate
• Our fair value estimate is 1.7% higher than Qantas Airways' analyst price target of AU$8.83

In this article we are going to estimate the intrinsic value of Qantas Airways Limited (ASX:QAN) 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Qantas Airways

What's The Estimated Valuation?

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$342.8m	AU$337.3m	AU$741.4m	AU$748.8m	AU$759.8m	AU$773.5m	AU$789.2m	AU$806.6m	AU$825.3m	AU$845.0m
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x2	Est @ 1.00%	Est @ 1.47%	Est @ 1.80%	Est @ 2.04%	Est @ 2.20%	Est @ 2.31%	Est @ 2.39%
Present Value (A$, Millions) Discounted @ 7.4%	AU$319	AU$292	AU$598	AU$563	AU$532	AU$504	AU$479	AU$456	AU$434	AU$414

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$4.6b

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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$845m× (1 + 2.6%) ÷ (7.4%– 2.6%) = AU$18b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$18b÷ ( 1 + 7.4%)¹⁰= AU$8.8b

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$13b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$8.9, the company appears about fair value at a 1.4% discount to where the stock price trades currently. 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Qantas Airways 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 7.4%, which is based on a levered beta of 1.170. 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 Qantas Airways

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. For Qantas Airways, we've compiled three pertinent items you should further research:

1. Risks: Take risks, for example - Qantas Airways has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for QAN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.