RELX PLC (LON:REL) Shares Could Be 28% Below Their Intrinsic Value Estimate

Today we will run through one way of estimating the intrinsic value of RELX PLC (LON:REL) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 RELX

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£2.21b	UK£2.38b	UK£2.35b	UK£2.59b	UK£2.68b	UK£2.75b	UK£2.81b	UK£2.86b	UK£2.91b	UK£2.95b
Growth Rate Estimate Source	Analyst x9	Analyst x8	Analyst x1	Analyst x1	Est @ 3.5%	Est @ 2.73%	Est @ 2.19%	Est @ 1.81%	Est @ 1.55%	Est @ 1.36%
Present Value (£, Millions) Discounted @ 5.3%	UK£2.1k	UK£2.2k	UK£2.0k	UK£2.1k	UK£2.1k	UK£2.0k	UK£2.0k	UK£1.9k	UK£1.8k	UK£1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£20b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 0.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£2.9b× (1 + 0.9%) ÷ (5.3%– 0.9%) = UK£69b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£69b÷ ( 1 + 5.3%)¹⁰= UK£41b

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£61b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£22.9, the company appears a touch undervalued at a 28% 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.

Important 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 RELX 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 5.3%, which is based on a levered beta of 0.894. 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For RELX, there are three essential items you should assess:

1. Risks: You should be aware of the 1 warning sign for RELX we've uncovered before considering an investment in the company.
2. Future Earnings: How does REL'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.
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 LSE every day. If you want to find the calculation for other stocks just search here.

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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.