Stock Analysis
- United Kingdom
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- Construction
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- LSE:BBY
Is There An Opportunity With Balfour Beatty plc's (LON:BBY) 32% Undervaluation?
Key Insights
- The projected fair value for Balfour Beatty is UK£6.32 based on 2 Stage Free Cash Flow to Equity
- Balfour Beatty's UK£4.27 share price signals that it might be 32% undervalued
- The UK£4.41 analyst price target for BBY is 30% less than our estimate of fair value
In this article we are going to estimate the intrinsic value of Balfour Beatty plc (LON:BBY) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
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.
See our latest analysis for Balfour Beatty
What's The Estimated Valuation?
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. To begin with, we have to get estimates of the next ten years of cash flows. 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) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (£, Millions) | UK£196.6m | UK£218.7m | UK£226.5m | UK£233.4m | UK£239.6m | UK£245.4m | UK£250.8m | UK£256.0m | UK£261.1m | UK£266.1m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Est @ 3.59% | Est @ 3.04% | Est @ 2.66% | Est @ 2.39% | Est @ 2.21% | Est @ 2.08% | Est @ 1.98% | Est @ 1.92% |
Present Value (£, Millions) Discounted @ 8.6% | UK£181 | UK£185 | UK£177 | UK£168 | UK£158 | UK£149 | UK£140 | UK£132 | UK£124 | UK£116 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.5b
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 (1.8%) 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 8.6%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£266m× (1 + 1.8%) ÷ (8.6%– 1.8%) = UK£3.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£3.9b÷ ( 1 + 8.6%)10= UK£1.7b
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 UK£3.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£4.3, the company appears quite good value at a 32% 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
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Balfour Beatty 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 8.6%, which is based on a levered beta of 1.255. 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 Balfour Beatty
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Construction market.
- Annual revenue is forecast to grow faster than the British market.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow slower than the British market.
Looking Ahead:
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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Balfour Beatty, we've put together three fundamental elements you should assess:
- Risks: Be aware that Balfour Beatty is showing 2 warning signs in our investment analysis , you should know about...
- Future Earnings: How does BBY'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 British 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.
Discover if Balfour Beatty might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
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About LSE:BBY
Balfour Beatty
Balfour Beatty plc finances, designs, develops, builds, and maintains infrastructure in the United Kingdom, the United States, and internationally.