In this article I am going to calculate the intrinsic value of Villa World Limited (ASX:VLW) using the discounted cash flows (DCF) model. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after March 2018 then I highly recommend you check out the latest calculation for Villa World here.

Is VLW fairly valued?

I’ve used the 2-stage growth 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, I took the analyst consensus forecast of VLW’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 9.59%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of AU$146.34M. Want to understand how I calculated this value? Read our detailed analysis here.

Above is a visual representation of how VLW’s earnings are expected to move going forward, which should give you an idea of VLW’s outlook. Secondly, I determine the terminal value, which accounts for all the future cash flows after the five years. I think it’s suitable to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is AU$481.05M.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is AU$627.39M. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of A$4.94, which, compared to the current share price of A$2.53, we find that Villa World is quite undervalued at a 48.82% discount to what it is available for right now.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 VLW, there are three relevant factors you should further examine:

1. Financial Health: Does VLW 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.

2. Future Earnings: How does VLW’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.

3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of VLW? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!