Stock Analysis

Are Investors Undervaluing A.G. BARR p.l.c. (LON:BAG) By 39%?

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LSE:BAG
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How far off is A.G. BARR p.l.c. (LON:BAG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for A.G. BARR

The calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (£, Millions) UK£25.1m UK£28.1m UK£32.6m UK£35.6m UK£38.1m UK£40.0m UK£41.6m UK£42.8m UK£43.8m UK£44.6m
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x3 Est @ 9.42% Est @ 6.87% Est @ 5.09% Est @ 3.84% Est @ 2.97% Est @ 2.36% Est @ 1.93%
Present Value (£, Millions) Discounted @ 4.8% UK£24.0 UK£25.5 UK£28.3 UK£29.5 UK£30.1 UK£30.2 UK£29.9 UK£29.4 UK£28.7 UK£27.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£283m

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 (0.9%) 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 4.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£45m× (1 + 0.9%) ÷ (4.8%– 0.9%) = UK£1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£1.2b÷ ( 1 + 4.8%)10= UK£728m

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£1.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£5.5, the company appears quite good value at a 39% 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.

dcf
LSE:BAG Discounted Cash Flow July 13th 2022

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 A.G. BARR 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 4.8%, which is based on a levered beta of 0.800. 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.

Next Steps:

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. The DCF model is not a perfect stock valuation tool. 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 A.G. BARR, there are three relevant factors you should explore:

  1. Risks: Every company has them, and we've spotted 1 warning sign for A.G. BARR you should know about.
  2. Future Earnings: How does BAG'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. 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 A.G. BARR 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.

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About LSE:BAG

A.G. BARR

A.G. BARR p.l.c., together with its subsidiaries, manufactures, distributes, and sells soft drinks and cocktail solutions in the United Kingdom and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation3
Future Growth2
Past Performance3
Financial Health6
Dividends4

Read more about these checks in the individual report sections or in our analysis model.

Flawless balance sheet average dividend payer.