Crunching the numbers
I’m 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 perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF (€, Millions)||€69.60||€108.16||€164.48||€315.00||€333.55|
|Source||Analyst x6||Analyst x10||Analyst x6||Analyst x1||Extrapolated @ (5.89%)|
|Present Value Discounted @ 10.48%||€63.00||€88.61||€121.97||€211.41||€202.62|
Present Value of 5-year Cash Flow (PVCF)= €687.60m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.3%. We discount this to today’s value at a cost of equity of 10.5%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €333.55m × (1 + 1.3%) ÷ (10.5% – 1.3%) = €3.67b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €3.67b ÷ ( 1 + 10.5%)5 = €2.23b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €2.92b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of €7.62. Relative to the current share price of €6.34, the stock is about right, perhaps slightly undervalued at a 16.92% discount to what it is available for right now.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at NH Hotel Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.5%, which is based on a levered beta of 1.055. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For NHH, I’ve compiled three key factors you should look at:
- Financial Health: Does NHH have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does NHH’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of NHH? 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 does a DCF calculation for every ES stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.