Key Insights

Rank Group's estimated fair value is UK£1.65 based on 2 Stage Free Cash Flow to Equity Rank Group's UK£1.02 share price signals that it might be 38% undervalued Our fair value estimate is 53% higher than Rank Group's analyst price target of UK£1.08

Today we will run through one way of estimating the intrinsic value of The Rank Group Plc (LON:RNK) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Rank Group

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (£, Millions)  UK£36.0m UK£49.7m UK£59.0m UK£65.7m UK£71.2m UK£75.6m UK£79.2m UK£82.1m UK£84.5m UK£86.6m Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Est @ 11.41% Est @ 8.36% Est @ 6.22% Est @ 4.73% Est @ 3.68% Est @ 2.95% Est @ 2.44% Present Value (£, Millions) Discounted @ 10%  UK£32.7 UK£40.9 UK£44.1 UK£44.6 UK£43.9 UK£42.4 UK£40.3 UK£37.9 UK£35.4 UK£33.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£395m



The second stage is also known as Terminal Value, this is the business's cash flow after 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 (1.2%) 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 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£87m× (1 + 1.2%) ÷ (10%– 1.2%) = UK£985m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£985m÷ ( 1 + 10%)10= UK£375m

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£771m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£1.0, the company appears quite undervalued at a 38% 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. dcf

Important 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Rank Group 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 10%, which is based on a levered beta of 1.276. 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 Rank Group

Strength

Debt is not viewed as a risk.

Weakness

No major weaknesses identified for RNK.

Opportunity

Forecast to reduce losses next year.

Has sufficient cash runway for more than 3 years based on current free cash flows.

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

Significant insider buying over the past 3 months.

Threat

Not expected to become profitable over the next 3 years.

Next Steps:

Whilst important, the DCF calculation 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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Rank Group, we've compiled three additional elements you should further examine:

Risks: For example, we've discovered 2 warning signs for Rank Group (1 is significant!) that you should be aware of before investing here. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for RNK'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 British 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.

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