- United Kingdom
- Consumer Durables
Is Taylor Wimpey plc (LON:TW.) Trading At A 36% Discount?
- Taylor Wimpey's estimated fair value is UK£1.78 based on 2 Stage Free Cash Flow to Equity
- Current share price of UK£1.14 suggests Taylor Wimpey is potentially 36% undervalued
- Our fair value estimate is 26% lower than Taylor Wimpey's analyst price target of UK£1.32
In this article we are going to estimate the intrinsic value of Taylor Wimpey plc (LON:TW.) by taking the expected 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. It may sound complicated, but actually it is quite simple!
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Taylor Wimpey
Is Taylor Wimpey Fairly Valued?
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. To start off with, we need to estimate 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.
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
|Levered FCF (£, Millions)||UK£285.7m||UK£252.1m||UK£287.8m||UK£432.0m||UK£479.1m||UK£517.3m||UK£548.0m||UK£572.6m||UK£592.6m||UK£609.1m|
|Growth Rate Estimate Source||Analyst x7||Analyst x9||Analyst x6||Analyst x1||Est @ 10.90%||Est @ 7.97%||Est @ 5.93%||Est @ 4.49%||Est @ 3.49%||Est @ 2.79%|
|Present Value (£, Millions) Discounted @ 8.8%||UK£263||UK£213||UK£224||UK£309||UK£315||UK£312||UK£304||UK£292||UK£278||UK£263|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£2.8b
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 (1.2%) 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 8.8%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£609m× (1 + 1.2%) ÷ (8.8%– 1.2%) = UK£8.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£8.1b÷ ( 1 + 8.8%)10= UK£3.5b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£6.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£1.1, the company appears quite undervalued at a 36% 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.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Taylor Wimpey 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 8.8%, which is based on a levered beta of 1.093. 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 Taylor Wimpey
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Dividend is in the top 25% of dividend payers in the market.
- No major weaknesses identified for TW..
- Good value based on P/E ratio and estimated fair value.
- Significant insider buying over the past 3 months.
- Annual earnings are forecast to decline for the next 3 years.
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. It's not possible to obtain a foolproof valuation with a DCF model. 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 Taylor Wimpey, we've put together three essential factors you should consider:
- Risks: You should be aware of the 2 warning signs for Taylor Wimpey (1 shouldn't be ignored!) we've uncovered before considering an investment in the company.
- Future Earnings: How does TW.'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: Do you like a good all-rounder? 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 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 helping make it simple.
Find out whether Taylor Wimpey is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Taylor Wimpey plc operates a residential developer in the United Kingdom and Spain.
Flawless balance sheet, undervalued and pays a dividend.