Key Insights

Using the 2 Stage Free Cash Flow to Equity, Seven Group Holdings fair value estimate is AU$57.45 Seven Group Holdings is estimated to be 31% undervalued based on current share price of AU$39.36 The AU$38.59 analyst price target for SVW is 33% 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 Seven Group Holdings Limited (ASX:SVW) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Seven Group Holdings

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 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 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$804.5m AU$882.0m AU$993.5m AU$1.28b AU$1.35b AU$1.41b AU$1.46b AU$1.50b AU$1.54b AU$1.58b Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x1 Analyst x1 Est @ 4.12% Est @ 3.53% Est @ 3.12% Est @ 2.83% Est @ 2.63% Present Value (A$, Millions) Discounted @ 7.9%  AU$745 AU$757 AU$790 AU$943 AU$922 AU$890 AU$853 AU$816 AU$777 AU$739

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$8.2b



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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$1.6b× (1 + 2.2%) ÷ (7.9%– 2.2%) = AU$28b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$28b÷ ( 1 + 7.9%)10= AU$13b

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$21b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$39.4, the company appears quite good value at a 31% 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

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Seven Group Holdings 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 1.252. 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 Seven Group Holdings

Strength

Debt is well covered by earnings and cashflows.

Weakness

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

Shareholders have been diluted in the past year.

Opportunity

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

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

Threat

Annual revenue is forecast to grow slower than the Australian market.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Seven Group Holdings, we've put together three relevant items you should consider:

Risks: Every company has them, and we've spotted  2 warning signs for Seven Group Holdings  you should know about. Future Earnings: How does SVW'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 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.

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.