Calculating The Intrinsic Value Of Naked Wines plc (LON:WINE)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Naked Wines fair value estimate is UK£0.86
• With UK£0.84 share price, Naked Wines appears to be trading close to its estimated fair value
• Analyst price target for WINE is UK£1.13, which is 31% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Naked Wines plc (LON:WINE) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Naked Wines

The Model

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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£29.0m	UK£11.7m	UK£5.30m	UK£3.30m	UK£2.44m	UK£2.00m	UK£1.76m	UK£1.62m	UK£1.53m	UK£1.48m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -54.52%	Est @ -37.79%	Est @ -26.08%	Est @ -17.89%	Est @ -12.15%	Est @ -8.13%	Est @ -5.32%	Est @ -3.35%
Present Value (£, Millions) Discounted @ 7.0%	UK£27.1	UK£10.2	UK£4.3	UK£2.5	UK£1.7	UK£1.3	UK£1.1	UK£0.9	UK£0.8	UK£0.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£51m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£1.5m× (1 + 1.2%) ÷ (7.0%– 1.2%) = UK£26m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£26m÷ ( 1 + 7.0%)¹⁰= UK£13m

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£64m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.8, the company appears about fair value at a 2.1% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Naked Wines 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 7.0%, which is based on a levered beta of 0.830. 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 Naked Wines

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. 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. For Naked Wines, we've compiled three pertinent elements you should consider:

1. Risks: Be aware that Naked Wines is showing 3 warning signs in our investment analysis , and 2 of those are a bit unpleasant...
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WINE'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. 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.

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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.