Stock Analysis

An Intrinsic Calculation For SSP Group plc (LON:SSPG) Suggests It's 27% Undervalued

LSE:SSPG
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Key Insights

  • SSP Group's estimated fair value is UK£2.38 based on 2 Stage Free Cash Flow to Equity
  • Current share price of UK£1.74 suggests SSP Group is potentially 27% undervalued
  • Our fair value estimate is 15% lower than SSP Group's analyst price target of UK£2.81

Does the July share price for SSP Group plc (LON:SSPG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 SSP Group

What's The Estimated Valuation?

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. 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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (£, Millions) UK£124.0m UK£193.4m UK£202.6m UK£210.4m UK£217.2m UK£223.3m UK£228.9m UK£234.1m UK£239.1m UK£243.9m
Growth Rate Estimate Source Analyst x3 Analyst x2 Est @ 4.76% Est @ 3.87% Est @ 3.24% Est @ 2.80% Est @ 2.49% Est @ 2.27% Est @ 2.12% Est @ 2.02%
Present Value (£, Millions) Discounted @ 12% UK£111 UK£154 UK£144 UK£133 UK£122 UK£112 UK£103 UK£93.6 UK£85.2 UK£77.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.1b

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 12%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£244m× (1 + 1.8%) ÷ (12%– 1.8%) = UK£2.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£2.4b÷ ( 1 + 12%)10= UK£760m

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£1.9b. 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£1.7, the company appears a touch undervalued at a 27% 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.

dcf
LSE:SSPG Discounted Cash Flow July 25th 2024

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 SSP 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 12%, which is based on a levered beta of 1.894. 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.

SWOT Analysis for SSP Group

Strength
  • Debt is well covered by cash flow.
Weakness
  • Earnings declined over the past year.
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Hospitality market.
Opportunity
  • Annual earnings are forecast to grow faster than the British market.
  • Good value based on P/S ratio and estimated fair value.
Threat
  • Dividends are not covered by earnings.
  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For SSP Group, we've compiled three further factors you should assess:

  1. Risks: For example, we've discovered 3 warning signs for SSP Group (1 can't be ignored!) that you should be aware of before investing here.
  2. Future Earnings: How does SSPG'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 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.

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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.