A Look At The Fair Value Of Victoria's Secret & Co. (NYSE:VSCO)

Key Insights

• Victoria's Secret's estimated fair value is US$25.20 based on 2 Stage Free Cash Flow to Equity
• With US$28.82 share price, Victoria's Secret appears to be trading close to its estimated fair value
• Analyst price target for VSCO is US$26.09, which is 3.5% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Victoria's Secret & Co. (NYSE:VSCO) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Victoria's Secret

What's The Estimated Valuation?

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 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)	US$231.8m	US$252.3m	US$217.8m	US$198.4m	US$187.4m	US$181.3m	US$178.4m	US$177.6m	US$178.3m	US$179.9m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ -13.66%	Est @ -8.90%	Est @ -5.56%	Est @ -3.23%	Est @ -1.59%	Est @ -0.45%	Est @ 0.35%	Est @ 0.91%
Present Value ($, Millions) Discounted @ 11%	US$209	US$205	US$159	US$131	US$111	US$97.1	US$86.1	US$77.3	US$69.9	US$63.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2b

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$180m× (1 + 2.2%) ÷ (11%– 2.2%) = US$2.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.1b÷ ( 1 + 11%)¹⁰= US$742m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$2.0b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$28.8, the company appears around fair value at the time of writing. 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. 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 Victoria's Secret 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 11%, which is based on a levered beta of 1.750. 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 Victoria's Secret

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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 Victoria's Secret, there are three essential aspects you should consider:

1. Risks: You should be aware of the 3 warning signs for Victoria's Secret we've uncovered before considering an investment in the company.
2. Future Earnings: How does VSCO'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

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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.