In this article I am going to calculate the intrinsic value of Qantas Airways Limited (ASX:QAN) 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 Qantas Airways here.

Is QAN fairly valued?

I will be 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. Firstly, I use the analyst consensus estimates of QAN’s levered free cash flow (FCF) over the next five years and discounted these figures 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 AU$4.38B. Keen to know how I arrived at this number? Check out our detailed analysis here.

The graph above shows how QAN’s earnings are expected to move in the future, which should give you an idea of QAN’s outlook. Now we need to determine the terminal value, which is the business’s cash flow after the first stage. It’s appropriate 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. Discounting the terminal value back five years gives us a present value of AU$11.52B.

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 AU$15.90B. 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$9.78, which, compared to the current share price of A$5.97, we find that Qantas Airways is quite undervalued at a 38.98% 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 QAN, I’ve compiled three essential aspects you should look at:

1. Financial Health: Does QAN 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 QAN’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 QAN? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!