Any Chance On CVS Group plc (LON:CVSG) 37% Undervaluation?

In this article, we’re going to estimate the intrinsic value of CVS Group plc (LON:CVSG) by projecting its future cash flows and then discounting them to today’s value. The discounted cash flow (DCF) model is the tool we will use for this. Don’t be put off by the jargon, the math behind it is actually quite simple.

However, remember that there are many ways to estimate the value of a business and a DCF is just one method. If you want to know more about the intrinsic value, you should read the Simply Wall St analysis model.

Check out our latest analysis for the CVS Group

The model

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that levels off towards the terminal value captured in the second phase of ‘steady growth’. First, we need to get estimates of cash flows for the next ten years. Where possible we use analyst estimates, but when these are not available we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We expect companies with declining free cash flow to slow their rate of contraction and companies with growing free cash flow to slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume that a dollar is worth more today than a dollar will be in the future, and so the sum of these future cash flows is then discounted to today’s value:

10-year free cash flow (FCF) estimate.

(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 638 million British pounds

After calculating the present value of future cash flows in the first 10 years, we need to calculate the terminal value, which takes into account all future cash flows after the first phase. The Gordon growth formula is used to calculate terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 0.9%. We discount the final cash flows to today’s value using a cost of equity rate of 5.2%.

final value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = £102m × (1 + 0.9%) ÷ (5.2% – 0.9%) = £2.4bn

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= UK£2.4b÷ (1 + 5.2%)¹⁰= UK £1.4bn

The total value or equity value is then the sum of the present value of the future cash flows, which in this case is £2.0 billion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of £18.3, the company appears fairly cheap at a 37% discount to the current share price. The assumptions in each calculation have a big impact on the score, so it’s better to take this as a rough estimate, not accurate to the last penny.

Important Assumptions

The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, so it does not provide a complete picture of a company’s potential performance. Because we view CVS Group as a potential shareholder, 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 used 5.2% which is based on a leveraged beta of 0.901. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the industry average of global peers with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable business.

Continue:

While a company’s valuation is important, it’s just one of many factors you need to evaluate for a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use for a DCF model is to test certain assumptions and theories to determine whether they would understate or overstate the company. For example, slightly adjusting the growth rate of the terminal value can dramatically change the overall result. What is the reason that the share price is below the intrinsic value? For the CVS Group, there are three basic elements to examine:

1. financial health: Does CVSG 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 CVSG’s growth rate compare to its competitors and the broader market? Dive deeper into analyst consensus numbers for the years ahead by interacting with our free analyst growth expectations chart.
3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of ​​what else you might be missing!

hp Simply Wall St updates its DCF calculation for each UK stock on a daily basis. So if you want to find the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.