I am going to run you through how I calculated the intrinsic value of Adairs Limited (ASX:ADH) using the discounted cash flow (DCF) method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Also note that this article was written in November 2017 so be sure check the latest calculation for Adairs here.

Crunching the numbers

I’ve used the 2-stage growth model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To begin, I pulled together the analyst consensus estimates of ADH’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 8.55%. 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 A$82M. Want to know how I calculated this value? Check out our detailed analysis here.

In the visual above, we see how how ADH’s top and bottom lines are expected to move in the future, which should give you an idea of ADH’s outlook. Now we need to determine the terminal value, which is the business’s cash flow after the first stage. I’ve decided to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes A$348M.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is A$430M. 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$2.59, which, compared to the current share price of A$1.63, we see that Adairs is quite undervalued at a 37.13% discount to what it is available for right now.

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 ADH, there are three fundamental factors you should further research:

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the ASX every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see pass 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.