Key Insights

Using the 2 Stage Free Cash Flow to Equity, Domain Holdings Australia fair value estimate is AU$3.22 With AU$3.79 share price, Domain Holdings Australia appears to be trading close to its estimated fair value Analyst price target for DHG is AU$3.50, which is 8.4% above our fair value estimate

In this article we are going to estimate the intrinsic value of Domain Holdings Australia Limited (ASX:DHG) 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 apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Domain Holdings Australia

Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:



10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$72.3m AU$80.6m AU$90.2m AU$101.7m AU$113.0m AU$121.4m AU$128.4m AU$134.3m AU$139.5m AU$144.1m Growth Rate Estimate Source Analyst x5 Analyst x5 Analyst x4 Analyst x3 Analyst x3 Est @ 7.40% Est @ 5.78% Est @ 4.65% Est @ 3.86% Est @ 3.30% Present Value (A$, Millions) Discounted @ 7.5%  AU$67.2 AU$69.8 AU$72.6 AU$76.1 AU$78.7 AU$78.6 AU$77.3 AU$75.3 AU$72.7 AU$69.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$738m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$144m× (1 + 2.0%) ÷ (7.5%– 2.0%) = AU$2.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$2.7b÷ ( 1 + 7.5%)10= AU$1.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$2.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$3.8, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind. dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Domain Holdings Australia as potential shareholders, 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've used 7.5%, which is based on a levered beta of 1.100. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Domain Holdings Australia

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Weakness

Earnings growth over the past year is below its 5-year average.

Dividend is low compared to the top 25% of dividend payers in the Interactive Media and Services market.

Expensive based on P/E ratio and estimated fair value.

Opportunity

Annual earnings are forecast to grow faster than the Australian market.

Threat

Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Domain Holdings Australia, there are three relevant factors you should further research:

Financial Health: Does DHG 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 DHG'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: Do you like a good all-rounder? 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 updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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