Stock Analysis
Is There An Opportunity With B&M European Value Retail S.A.'s (LON:BME) 50% Undervaluation?
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, B&M European Value Retail fair value estimate is UK£8.99
- B&M European Value Retail is estimated to be 50% undervalued based on current share price of UK£4.53
- Our fair value estimate is 53% higher than B&M European Value Retail's analyst price target of UK£5.88
How far off is B&M European Value Retail S.A. (LON:BME) 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 forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for B&M European Value Retail
The Calculation
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.
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) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF (£, Millions) | UK£343.1m | UK£374.9m | UK£415.1m | UK£451.0m | UK£477.6m | UK£500.1m | UK£519.5m | UK£536.6m | UK£552.1m | UK£566.4m |
Growth Rate Estimate Source | Analyst x7 | Analyst x7 | Analyst x5 | Analyst x1 | Est @ 5.90% | Est @ 4.71% | Est @ 3.88% | Est @ 3.29% | Est @ 2.88% | Est @ 2.60% |
Present Value (£, Millions) Discounted @ 7.0% | UK£321 | UK£327 | UK£339 | UK£344 | UK£340 | UK£333 | UK£323 | UK£312 | UK£300 | UK£288 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£3.2b
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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£566m× (1 + 1.9%) ÷ (7.0%– 1.9%) = UK£11b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£11b÷ ( 1 + 7.0%)10= UK£5.8b
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£9.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£4.5, the company appears quite undervalued at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 B&M European Value Retail 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 1.231. 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 B&M European Value Retail
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings growth over the past year is below its 5-year average.
- Annual revenue is forecast to grow faster than the British market.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow slower than the British market.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For B&M European Value Retail, there are three relevant aspects you should look at:
- Risks: Case in point, we've spotted 2 warning signs for B&M European Value Retail you should be aware of.
- Future Earnings: How does BME'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 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 here to simplify it.
Discover if B&M European Value Retail might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About LSE:BME
B&M European Value Retail
Operates general merchandise and grocery stores.