Estimating The Fair Value Of CAR Group Limited (ASX:CAR)

editorial-team@simplywallst.com (Simply Wall St)

Tue, Nov 28, 2023, 10:15 PM 6 min read

Key Insights

Using the 2 Stage Free Cash Flow to Equity, CAR Group fair value estimate is AU$27.72
With AU$27.21 share price, CAR Group appears to be trading close to its estimated fair value
Our fair value estimate is 2.9% lower than CAR Group's analyst price target of AU$28.55

How far off is CAR Group Limited (ASX:CAR) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for CAR Group

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. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$351.1m	AU$397.5m	AU$453.6m	AU$521.1m	AU$583.4m	AU$629.3m	AU$667.9m	AU$700.7m	AU$729.2m	AU$754.5m
Growth Rate Estimate Source	Analyst x7	Analyst x7	Analyst x6	Analyst x3	Analyst x3	Est @ 7.87%	Est @ 6.13%	Est @ 4.92%	Est @ 4.07%	Est @ 3.47%
Present Value (A$, Millions) Discounted @ 7.6%	AU$326	AU$343	AU$364	AU$389	AU$404	AU$405	AU$400	AU$390	AU$377	AU$362

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$3.8b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.1%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$755m× (1 + 2.1%) ÷ (7.6%– 2.1%) = AU$14b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$14b÷ ( 1 + 7.6%)¹⁰= AU$6.7b

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$10b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$27.2, the company appears about fair value at a 1.8% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf — ASX:CAR Discounted Cash Flow November 29th 2023

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 CAR Group 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 7.6%, which is based on a levered beta of 1.106. 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 CAR Group

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Interactive Media and Services market.

Shareholders have been diluted in the past year.

Opportunity

Annual revenue is forecast to grow faster than the Australian market.

Current share price is below our estimate of fair value.

Threat

Dividends are not covered by cash flow.

Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For CAR Group, we've compiled three additional factors you should further research:

Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with CAR Group (at least 1 which is potentially serious) , and understanding these should be part of your investment process.
Future Earnings: How does CAR'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.