Ashtead Group plc (LON:AHT) Shares Could Be 38% Below Their Intrinsic Value Estimate

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Ashtead Group fair value estimate is UK£76.92

• Ashtead Group is estimated to be 38% undervalued based on current share price of UK£47.67

• The US$60.12 analyst price target for AHT is 22% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Ashtead Group plc (LON:AHT) by taking the expected future cash flows and discounting them to today's value. This will be done using 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Ashtead Group

The Model

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. 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$434.5m	US$1.07b	US$1.36b	US$1.28b	US$2.67b	US$3.24b	US$3.73b	US$4.15b	US$4.49b	US$4.77b
Growth Rate Estimate Source	Analyst x5	Analyst x7	Analyst x5	Analyst x1	Analyst x1	Est @ 21.18%	Est @ 15.28%	Est @ 11.15%	Est @ 8.26%	Est @ 6.24%
Present Value ($, Millions) Discounted @ 9.0%	US$399	US$902	US$1.0k	US$904	US$1.7k	US$1.9k	US$2.0k	US$2.1k	US$2.1k	US$2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$15b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$4.8b× (1 + 1.5%) ÷ (9.0%– 1.5%) = US$65b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$65b÷ ( 1 + 9.0%)¹⁰= US$27b

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 US$43b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£47.7, the company appears quite good value 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.

LSE:AHT Discounted Cash Flow January 18th 2024

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 Ashtead 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 9.0%, which is based on a levered beta of 1.262. 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 Ashtead Group

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Debt is well covered by earnings.

Weakness

• Earnings growth over the past year underperformed the Trade Distributors industry.

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

Opportunity

• Annual revenue is forecast to grow faster than the British market.

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

Threat

• Debt is not well covered by operating cash flow.

• Paying a dividend but company has no free cash flows.

• Annual earnings are forecast to grow slower than the British market.

Looking Ahead:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Ashtead Group, there are three further factors you should consider:

1. Risks: For example, we've discovered 1 warning sign for Ashtead Group that you should be aware of before investing here.

2. Future Earnings: How does AHT'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.

3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks 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.