Britvic plc (LON:BVIC) shares could be 37% below their estimated intrinsic value

Key findings

• Britvic’s estimated fair value is GBP 18.63 based on 2-step free cash flow to equity

• Britvic is estimated to be 37% undervalued based on the current share price of GBP 11.75.

• The analyst price target for BVIC is GBP 10.75, 42% below our fair value estimate.

Today we’re going to go through one way to estimate the intrinsic value of Britvic plc (LON:BVIC) by taking the expected future cash flows and discounting them to today’s value. We’re going to use the Discounted Cash Flow (DCF) model on this occasion. There’s actually not too much involved in it, even though it might seem quite complex.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. For those who enjoy stock analysis, the analysis model from Simply Wall St listed here might be of interest.

Check out our latest analysis for Britvic

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 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:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = £1.5 billion

The second period is also called the terminal value. This is the company’s cash flow after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year Treasury 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 6.2%.

The story goes on

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = £244 million × (1 + 1.8%) ÷ (6.2% – 1.8%) = £5.6 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= £5.6 billion ÷ (1 + 6.2%)¹⁰= £3.1 billion

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, giving us the total equity value, which in this case is £4.6 billion. In the final step, we divide the equity value by the number of shares in issue. Compared to the current share price of £11.8, the company looks quite undervalued at a 37% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep that in mind.

Important assumptions

We would like to point out that the key 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 does not take into account the possible 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 are considering Britvic 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 have used 6.2%, which is based on a leveraged beta of 0.802. 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 an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Britvic

Strength

weakness

Opportunity

Danger

Go on:

Valuation is only one side of the coin when building your investment thesis, and just one of many factors you need to evaluate for a company. It’s not possible to get a foolproof valuation using a DCF model. Instead, the best use of 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 is growing at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome could be very different. Why is the intrinsic value higher than the current share price? For Britvic, we’ve compiled three other factors for you to consider:

1. Risks: For example, we discovered 2 warning signs for Britvic that you should know before investing here.

2. Future income: How does BVIC’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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