- United Kingdom
- Specialty Stores
A Look At The Intrinsic Value Of WH Smith PLC (LON:SMWH)
- The projected fair value for WH Smith is UK£16.21 based on 2 Stage Free Cash Flow to Equity
- Current share price of UK£14.04 suggests WH Smith is potentially trading close to its fair value
- Analyst price target for SMWH is UK£19.51, which is 20% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of WH Smith PLC (LON:SMWH) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for WH Smith
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
|Levered FCF (£, Millions)||UK£75.8m||UK£129.7m||UK£155.6m||UK£174.3m||UK£189.7m||UK£202.0m||UK£211.9m||UK£219.8m||UK£226.4m||UK£231.9m|
|Growth Rate Estimate Source||Analyst x4||Analyst x4||Analyst x4||Est @ 12.06%||Est @ 8.79%||Est @ 6.50%||Est @ 4.89%||Est @ 3.77%||Est @ 2.98%||Est @ 2.43%|
|Present Value (£, Millions) Discounted @ 9.8%||UK£69.0||UK£108||UK£117||UK£120||UK£119||UK£115||UK£110||UK£104||UK£97.5||UK£90.9|
("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. 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 9.8%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£232m× (1 + 1.2%) ÷ (9.8%– 1.2%) = UK£2.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£2.7b÷ ( 1 + 9.8%)10= UK£1.1b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£2.1b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£14.0, the company appears about fair value at a 13% 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.
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 WH Smith 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 9.8%, which is based on a levered beta of 1.243. 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 WH Smith
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.
- Annual earnings are forecast to grow faster than the British market.
- Current share price is below our estimate of fair value.
- Revenue is forecast to grow slower than 20% per year.
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. For WH Smith, we've put together three additional elements you should further research:
- Risks: Be aware that WH Smith is showing 1 warning sign in our investment analysis , you should know about...
- Future Earnings: How does SMWH'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 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.
Valuation is complex, but we're helping make it simple.
Find out whether WH Smith 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.View the Free Analysis
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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.
WH Smith PLC operates as a retailer in the United Kingdom and internationally.
High growth potential and slightly overvalued.