An Intrinsic Calculation For On the Beach Group plc (LON:OTB) Suggests It's 24% Undervalued

Key Insights

• On the Beach Group's estimated fair value is UK£1.98 based on 2 Stage Free Cash Flow to Equity
• On the Beach Group is estimated to be 24% undervalued based on current share price of UK£1.51
• Analyst price target for OTB is UK£2.23, which is 12% above our fair value estimate

In this article we are going to estimate the intrinsic value of On the Beach Group plc (LON:OTB) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. 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 On the Beach Group

Crunching The Numbers

We're 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 a stable growth rate. 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, 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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£10.9m	UK£23.0m	UK£23.8m	UK£24.3m	UK£24.8m	UK£25.3m	UK£25.7m	UK£26.0m	UK£26.4m	UK£26.7m
Growth Rate Estimate Source	Analyst x6	Analyst x7	Analyst x5	Est @ 2.38%	Est @ 2.01%	Est @ 1.75%	Est @ 1.57%	Est @ 1.45%	Est @ 1.36%	Est @ 1.30%
Present Value (£, Millions) Discounted @ 8.1%	UK£10.1	UK£19.7	UK£18.8	UK£17.8	UK£16.8	UK£15.8	UK£14.9	UK£13.9	UK£13.1	UK£12.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£153m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£27m× (1 + 1.2%) ÷ (8.1%– 1.2%) = UK£388m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£388m÷ ( 1 + 8.1%)¹⁰= UK£178m

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£331m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£1.5, the company appears a touch undervalued at a 24% 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

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 On the Beach Group 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 8.1%, which is based on a levered beta of 1.000. 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 On the Beach Group

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 On the Beach Group, we've compiled three important elements you should further research:

1. Risks: You should be aware of the 1 warning sign for On the Beach Group we've uncovered before considering an investment in the company.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for OTB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. 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. 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.