An Intrinsic Calculation For A.G. BARR p.l.c. (LON:BAG) Suggests It's 34% Undervalued

Key Insights

• The projected fair value for A.G. BARR is UK£7.84 based on 2 Stage Free Cash Flow to Equity

• A.G. BARR is estimated to be 34% undervalued based on current share price of UK£5.20

• Analyst price target for BAG is UK£5.99 which is 24% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of A.G. BARR p.l.c. (LON:BAG) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for A.G. BARR

Crunching The Numbers

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£22.1m	UK£25.4m	UK£31.2m	UK£36.0m	UK£43.3m	UK£48.6m	UK£53.0m	UK£56.6m	UK£59.4m	UK£61.7m
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x5	Analyst x2	Analyst x1	Est @ 12.32%	Est @ 9.00%	Est @ 6.67%	Est @ 5.04%	Est @ 3.90%
Present Value (£, Millions) Discounted @ 6.8%	UK£20.7	UK£22.3	UK£25.6	UK£27.6	UK£31.1	UK£32.7	UK£33.4	UK£33.4	UK£32.8	UK£31.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£292m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£62m× (1 + 1.2%) ÷ (6.8%– 1.2%) = UK£1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£1.1b÷ ( 1 + 6.8%)¹⁰= UK£580m

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£871m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£5.2, the company appears quite good value at a 34% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 A.G. BARR 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 6.8%, which is based on a levered beta of 0.800. 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 A.G. BARR

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

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

Opportunity

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

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

Threat

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

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For A.G. BARR, there are three important elements you should assess:

1. Risks: For instance, we've identified 1 warning sign for A.G. BARR that you should be aware of.

2. Future Earnings: How does BAG'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. 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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