Key Insights

Using the 2 Stage Free Cash Flow to Equity, Bapcor fair value estimate is AU$9.82 Current share price of AU$5.55 suggests Bapcor is potentially 43% undervalued The AU$6.96 analyst price target for BAP is 29% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Bapcor Limited (ASX:BAP) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 Bapcor

What's The Estimated Valuation?

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 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 (A$, Millions)  AU$166.1m AU$165.2m AU$181.3m AU$174.6m AU$188.0m AU$193.8m AU$199.1m AU$204.2m AU$209.1m AU$214.0m Growth Rate Estimate Source Analyst x2 Analyst x3 Analyst x3 Analyst x2 Analyst x1 Est @ 3.06% Est @ 2.77% Est @ 2.56% Est @ 2.42% Est @ 2.32% Present Value (A$, Millions) Discounted @ 7.3%  AU$155 AU$143 AU$147 AU$132 AU$132 AU$127 AU$121 AU$116 AU$111 AU$105

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.3b

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 (2.1%) 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 7.3%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$214m× (1 + 2.1%) ÷ (7.3%– 2.1%) = AU$4.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$4.2b÷ ( 1 + 7.3%)10= AU$2.0b

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$3.3b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$5.6, the company appears quite good value at a 43% 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. ASX:BAP Discounted Cash Flow December 27th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Bapcor 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 7.3%, which is based on a levered beta of 1.052. 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 Bapcor

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 Retail Distributors market.

Opportunity

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

Trading below our estimate of fair value by more than 20%.

Significant insider buying over the past 3 months.

Threat

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

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Bapcor, we've compiled three essential elements you should further examine:

Risks: You should be aware of the 1 warning sign for Bapcor we've uncovered before considering an investment in the company. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BAP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.