Calculating the intrinsic value of Aristocrat Leisure Limited (ASX:ALL)

Key findings

• Using the 2-step free cash flow to equity, the fair value of Aristocrat Leisure is AU$58.55
• Aristocrat Leisure’s share price of AU$52.01 suggests that the share price is at a similar level to the estimated fair value.
• The analyst price target of AU$51.88 for ALL is 11% below our fair value estimate

How far is Aristocrat Leisure Limited (ASX:ALL) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by projecting its future cash flows and then discounting those to today’s value. The Discounted Cash Flow (DCF) model is the tool we will use for this. Models like these may seem incomprehensible to a layperson, but they are relatively simple to understand.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. For those who enjoy stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for Aristocrat Leisure

The model

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to estimate the next ten years’ worth 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 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 more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less 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) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = AU$14 billion

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.3%. We discount the terminal cash flows to today’s value at a cost of equity of 7.4%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$2.4 billion × (1 + 2.3%) ÷ (7.4% – 2.3%) = AU$47 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= AU$47 billion ÷ ( 1 + 7.4 %)¹⁰= AU$23 billion

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is AU$37 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$52.0, the company appears roughly fairly valued at an 11% discount to the current share price. However, remember that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore does not provide a complete picture of a company’s potential performance. Since we view Aristocrat Leisure as prospective 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 7.4%, which is based on a levered beta of 1.121. Beta is a measure of a stock’s volatility relative to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with a set limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Aristocrat Leisure

Go on:

Although the DCF calculation is important, ideally it should not be the only analysis you look at for a company. It is not possible to get a foolproof valuation using a DCF model. You should rather apply different cases and assumptions and see how they affect the valuation of the company. For example, if the growth rate of the terminal value is adjusted slightly, it can change the overall result dramatically. For Aristocrat Leisure, we have compiled three relevant elements for you to look at:

1. Financial health: Does ALL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.
2. Future income: How is ALL’s growth rate compared to 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 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 you might be missing out on!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the ASX 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 the basis of 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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