Key Insights

Using the 2 Stage Free Cash Flow to Equity, Reece fair value estimate is AU$14.66 Reece's AU$12.15 share price indicates it is trading at similar levels as its fair value estimate The AU$11.86 analyst price target for REH is 19% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Reece Limited (ASX:REH) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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The Method

We are going to use a two-stage DCF 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 with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Levered FCF (A$, Millions)  AU$421.9m AU$366.3m AU$453.4m AU$473.3m AU$492.3m AU$510.8m AU$528.9m AU$547.0m AU$565.2m AU$583.6m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x2 Est @ 4.40% Est @ 4.01% Est @ 3.74% Est @ 3.55% Est @ 3.42% Est @ 3.33% Est @ 3.26% Present Value (A$, Millions) Discounted @ 7.9%  AU$391 AU$314 AU$361 AU$349 AU$336 AU$323 AU$310 AU$297 AU$284 AU$272

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$3.2b



We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (3.1%) 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 7.9%.

Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = AU$584m× (1 + 3.1%) ÷ (7.9%– 3.1%) = AU$12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$12b÷ ( 1 + 7.9%)10= AU$5.8b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is AU$9.1b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$12.2, the company appears about fair value at a 17% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.ASX:REH Discounted Cash Flow October 29th 2025

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Reece 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 7.9%, which is based on a levered beta of 1.145. 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.

See our latest analysis for Reece

SWOT Analysis for Reece

Strength

Debt is not viewed as a risk.

Dividends are covered by earnings and cash flows.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Trade Distributors market.

Opportunity

Annual earnings are forecast to grow for the next 3 years.

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

Threat

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

Moving On:

Although the valuation of a company is important, 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Reece, there are three further elements you should further research:

Financial Health: Does REH 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 REH'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.