Key Insights

The projected fair value for Victoria is UK£6.03 based on 2 Stage Free Cash Flow to Equity Victoria's UK£5.62 share price indicates it is trading at similar levels as its fair value estimate Peers of Victoria are currently trading on average at a 15% premium

In this article we are going to estimate the intrinsic value of Victoria PLC (LON:VCP) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. 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.

View our latest analysis for Victoria

The Method

We're 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 a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:



10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (£, Millions)  UK£52.4m UK£64.8m UK£73.9m UK£81.6m UK£87.8m UK£92.8m UK£96.9m UK£100.3m UK£103.2m UK£105.7m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 14.11% Est @ 10.29% Est @ 7.62% Est @ 5.75% Est @ 4.44% Est @ 3.52% Est @ 2.88% Est @ 2.43% Present Value (£, Millions) Discounted @ 13%  UK£46.2 UK£50.6 UK£51.0 UK£49.7 UK£47.2 UK£44.1 UK£40.7 UK£37.2 UK£33.8 UK£30.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£431m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£106m× (1 + 1.4%) ÷ (13%– 1.4%) = UK£907m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£907m÷ ( 1 + 13%)10= UK£262m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£694m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£5.6, the company appears about fair value at a 6.8% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent. dcf

Important Assumptions

Now 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 Victoria 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 13%, which is based on a levered beta of 2.000. 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 Victoria

Strength

Earnings growth over the past year exceeded the industry.

Weakness

Interest payments on debt are not well covered.

Opportunity

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

Current share price is below our estimate of fair value.

Threat

Debt is not well covered by operating cash flow.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Victoria, we've compiled three pertinent items you should consider:

Risks: Every company has them, and we've spotted  4 warning signs for Victoria  (of which 1 is potentially serious!) you should know about. Future Earnings: How does VCP'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.