Key Insights
- The projected fair value for GB Group is UK£2.82 based on 2 Stage Free Cash Flow to Equity
- With UK£2.43 share price, GB Group appears to be trading close to its estimated fair value
- Analyst price target for GBG is UK£4.23, which is 50% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of GB Group plc (LON:GBG) as an investment opportunity 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. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for GB Group
Crunching The Numbers
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (£, Millions) | UK£44.8m | UK£53.3m | UK£55.1m | UK£56.5m | UK£57.7m | UK£58.8m | UK£59.8m | UK£60.7m | UK£61.6m | UK£62.5m |
Growth Rate Estimate Source | Analyst x6 | Analyst x6 | Analyst x4 | Est @ 2.53% | Est @ 2.14% | Est @ 1.87% | Est @ 1.68% | Est @ 1.55% | Est @ 1.46% | Est @ 1.39% |
Present Value (£, Millions) Discounted @ 8.9% | UK£41.1 | UK£45.0 | UK£42.7 | UK£40.2 | UK£37.7 | UK£35.2 | UK£32.9 | UK£30.7 | UK£28.6 | UK£26.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£360m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 8.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£62m× (1 + 1.2%) ÷ (8.9%– 1.2%) = UK£823m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£823m÷ ( 1 + 8.9%)10= UK£350m
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£711m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£2.4, the company appears about fair value at a 14% 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
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 GB 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 8.9%, which is based on a levered beta of 1.102. 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 GB Group
- Debt is not viewed as a risk.
- Dividend is low compared to the top 25% of dividend payers in the Software market.
- Expected to breakeven next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Good value based on P/S ratio and estimated fair value.
- Paying a dividend but company is unprofitable.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For GB Group, we've put together three essential factors you should look at:
- Financial Health: Does GBG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GBG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks 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.
About AIM:GBG
GB Group
Provides identity data intelligence products and services in the United Kingdom, the United States, Australia, and internationally.
Undervalued with reasonable growth potential.