An Intrinsic Calculation For BT Group plc (LON:BT.A) Shows It’s 32.62% Undervalued

Simply Wall St.

Mon, Oct 22, 2018, 2:37 AM

How far off is BT Group plc (LON:BT.A) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for BT Group by following the link below.

Check out our latest analysis for BT Group

Step by step through the calculation

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF (£, Millions)	£2.34k	£2.20k	£2.55k	£2.64k	£2.65k
Source	Analyst x11	Analyst x11	Analyst x9	Analyst x6	Analyst x4
Present Value Discounted @ 8.28%	£2.16k	£1.88k	£2.01k	£1.92k	£1.78k

Present Value of 5-year Cash Flow (PVCF)= UK£9.8b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.4%. We discount this to today’s value at a cost of equity of 8.3%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = UK£2.7b × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£39.1b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = UK£39.1b ÷ ( 1 + 8.3%)⁵ = UK£26.3b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is UK£36.0b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of £3.66. Compared to the current share price of £2.47, the stock is quite undervalued at a 33% discount to what it is available for right now.

LSE:BT.A Intrinsic Value Export October 22nd 18

Important 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at BT Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.3%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For BT.A, I’ve put together three essential aspects you should look at:

Financial Health: Does BT.A have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does BT.A’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: Are there other high quality stocks you could be holding instead of BT.A? 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 does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Terms and Privacy Policy

Your Privacy Choices

Utah Privacy Notice

More Info