Fair value estimate of PZ Cussons plc (LON:PZC)

Key findings

• The forecast fair value for PZ Cussons is £1.18 based on 2-step free cash flow to equity

• PZ Cussons’ UK share price of £1.02 suggests the price is at a similar level to the estimated fair value

• Our fair value estimate is 19% below PZ Cussons’ analyst price target of GBP 1.45.

How far is PZ Cussons plc (LON:PZC) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by estimating the company’s future cash flows and discounting them to their current value. One way to do this is by applying the Discounted Cash Flow (DCF) model. Don’t be put off by the technical jargon, the math behind it is actually quite simple.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you want to learn more about intrinsic value, you should take a look at Simply Wall St’s analysis model.

Check out our latest analysis for PZ Cussons

The method

We use the two-stage growth model, which simply means that we consider two stages of the company’s growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. In the first stage, we need to estimate the company’s cash flows for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = £256 million

The story goes on

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.8%) 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 9.1%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = £41 million × (1 + 1.8%) ÷ (9.1% – 1.8%) = £571 million

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= £571 million ÷ (1 + 9.1%)¹⁰= £238 million

The total value or equity value is then the sum of the present value of future cash flows, which in this case is £495m. The final step is to divide the equity value by the number of shares in issue. Compared to the current share price of £1.0, the company appears to be about fair value, at a 14% discount to the current share price. However, remember that this is only an approximate valuation and as with any complex formula, where rubbish comes in, rubbish comes out.

Important assumptions

The main 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 repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider PZ Cussons 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 takes debt into account. In this calculation, we used 9.1%, which is based on a leveraged beta of 1.344. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for PZ Cussons

Strength

weakness

Opportunity

Danger

Go on:

While the valuation of a company is important, ideally it should not be the only analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Rather, they should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For PZ Cussons, there are three key elements to consider:

1. Risks: Take risks, for example – PZ Cussons has 1 warning sign In our opinion, you should be aware of this.

2. Future income: How does PZC’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS The Simply Wall St app does a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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