Do investors undervalue Bonhill Group Plc (LON: BONH) by 45%?

Today we are going to review one way to estimate the intrinsic value of Bonhill Group Plc (LON: BONH) by taking forecasts of the company’s future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.

We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.

Check out our latest analysis for the Bonhill Group

Step by step in the calculation

We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :

10-year Free Cash Flow (FCF) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = £ 10 million in the UK

The story continues

The second stage is also known as terminal value, this is the cash flow of the business 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 used the 5-year average of the 10-year government bond yield (0.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 5.8%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = UK £ 1.1m × (1 + 0.9%) ÷ (5.8% –0.9%) = UK £ 24m

Present value of terminal value (PVTV)= TV / (1 + r)^ten= UK £ 24m ÷ (1 + 5.8%)^ten= 14 million pounds sterling in the United Kingdom

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is £ 24million. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current UK £ 0.1 share price, the company looks quite good value with a 45% discount to the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

The hypotheses

The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Bonhill 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 takes debt into account. In this calculation, we used 5.8%, which is based on a leveraged beta of 0.911. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

To move on :

While important, calculating DCF ideally won’t be the only piece of analysis you’ll look at for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For Bonhill Group, we have compiled three additional factors that you need to assess:

1. Risks: Take risks, for example – Bonhill Group has 2 warning signs we think you should be aware.

2. Future benefits: How does BONH’s growth rate compare to that of its peers and the broader market? Deepen the number of analyst consensus for the coming years by interacting with our free chart of analysts’ growth expectations.

3. Other high quality alternatives: Do you like a good all-rounder? To explore our interactive list of high quality actions to get an idea of ​​what else you might be missing!

PS. Simply Wall St updates its DCF calculation for every UK stock every day, so if you want to find the intrinsic value of any other stock you just need to search here.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

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