A Look At The Fair Value Of Young & Co.'s Brewery, P.L.C. (LON:YNGA)

Key Insights

• Young's Brewery's estimated fair value is UK£8.87 based on 2 Stage Free Cash Flow to Equity

• With UK£9.64 share price, Young's Brewery appears to be trading close to its estimated fair value

• The UK£14.23 analyst price target for YNGA is 60% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Young & Co.'s Brewery, P.L.C. (LON:YNGA) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Young's Brewery

Is Young's Brewery Fairly Valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	-UK£45.0m	UK£32.1m	UK£37.4m	UK£41.2m	UK£44.4m	UK£47.0m	UK£49.1m	UK£51.0m	UK£52.5m	UK£53.9m
Growth Rate Estimate Source	Analyst x1	Analyst x3	Analyst x3	Est @ 10.26%	Est @ 7.67%	Est @ 5.86%	Est @ 4.60%	Est @ 3.71%	Est @ 3.09%	Est @ 2.65%
Present Value (£, Millions) Discounted @ 9.0%	-UK£41.3	UK£27.1	UK£28.9	UK£29.3	UK£28.9	UK£28.1	UK£27.0	UK£25.7	UK£24.3	UK£22.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£201m

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. 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 (1.6%) 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 9.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£54m× (1 + 1.6%) ÷ (9.0%– 1.6%) = UK£750m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£750m÷ ( 1 + 9.0%)¹⁰= UK£318m

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£519m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£9.6, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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. 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 Young's Brewery 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 1.334. 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 Young's Brewery

Strength

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

• Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

• Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Young's Brewery, there are three further items you should consider:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Young's Brewery .

2. Future Earnings: How does YNGA'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM 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.