Using the 2 Stage Free Cash Flow to Equity, Grit Real Estate Income Group fair value estimate is UK£0.10
Current share price of UK£0.12 suggests Grit Real Estate Income Group is potentially trading close to its fair value
Grit Real Estate Income Group's peers seem to be trading at a higher premium to fair value based onthe industry average of -1,026%
How far off is Grit Real Estate Income Group Limited (LON:GR1T) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.
A DCF is all about the idea that a dollar in the future is less valuable 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) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$14.5m
US$11.6m
US$10.1m
US$9.24m
US$8.74m
US$8.47m
US$8.34m
US$8.30m
US$8.33m
US$8.40m
Growth Rate Estimate Source
Est @ -28.95%
Est @ -19.63%
Est @ -13.11%
Est @ -8.54%
Est @ -5.35%
Est @ -3.11%
Est @ -1.54%
Est @ -0.45%
Est @ 0.32%
Est @ 0.86%
Present Value ($, Millions) Discounted @ 16%
US$12.5
US$8.7
US$6.5
US$5.2
US$4.2
US$3.5
US$3.0
US$2.6
US$2.2
US$2.0
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$50m
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 (2.1%) 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 16%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$63m÷ ( 1 + 16%)10= US$15m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$65m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.1, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
LSE:GR1T Discounted Cash Flow November 11th 2024
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Grit Real Estate Income 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 16%, which is based on a levered beta of 2.000. 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 Grit Real Estate Income Group
Strength
No major strengths identified for GR1T.
Weakness
Interest payments on debt are not well covered.
Current share price is above our estimate of fair value.
Opportunity
Has sufficient cash runway for more than 3 years based on current free cash flows.
Lack of analyst coverage makes it difficult to determine GR1T's earnings prospects.
Threat
Debt is not well covered by operating cash flow.
Next Steps:
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 Grit Real Estate Income Group, there are three pertinent items you should further examine:
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. The Simply Wall St app conducts 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 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.
