How far off is GrainCorp Limited (ASX:GNC) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (A$, Millions)
AU$151.4m
AU$120.4m
AU$118.5m
AU$90.0m
AU$80.9m
AU$75.8m
AU$72.9m
AU$71.6m
AU$71.1m
AU$71.3m
Growth Rate Estimate Source
Analyst x2
Analyst x2
Analyst x2
Analyst x1
Est @ -10.12%
Est @ -6.36%
Est @ -3.73%
Est @ -1.89%
Est @ -0.60%
Est @ 0.30%
Present Value (A$, Millions) Discounted @ 6.4%
AU$142
AU$106
AU$98.4
AU$70.3
AU$59.4
AU$52.3
AU$47.3
AU$43.6
AU$40.7
AU$38.4
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = AU$699m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.4%) 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 6.4%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.8b÷ ( 1 + 6.4%)10= AU$990m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$1.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$9.1, 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.
ASX:GNC Discounted Cash Flow September 15th 2024
Important 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 GrainCorp 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 6.4%, which is based on a levered beta of 0.965. 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 GrainCorp
Strength
Debt is well covered by cash flow.
Dividends are covered by earnings and cash flows.
Weakness
Earnings declined over the past year.
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Threat
Annual earnings are forecast to grow slower than the Australian market.
Next Steps:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For GrainCorp, there are three relevant factors you should look at:
Risks: As an example, we've found 3 warning signs for GrainCorp (1 shouldn't be ignored!) that you need to consider before investing here.
Future Earnings: How does GNC'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.
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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.
