Calculating The Intrinsic Value Of Collins Foods Limited (ASX:CKF)

Key Insights

• Collins Foods' estimated fair value is AU$12.34 based on 2 Stage Free Cash Flow to Equity

• With AU$10.25 share price, Collins Foods appears to be trading close to its estimated fair value

• Our fair value estimate is 2.3% higher than Collins Foods' analyst price target of AU$12.06

In this article we are going to estimate the intrinsic value of Collins Foods Limited (ASX:CKF) by estimating the company's future cash flows and discounting them to their present 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.

See our latest analysis for Collins Foods

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

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$79.0m	AU$78.4m	AU$93.3m	AU$91.8m	AU$102.3m	AU$108.4m	AU$113.6m	AU$118.2m	AU$122.4m	AU$126.1m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x4	Analyst x2	Analyst x2	Est @ 6.00%	Est @ 4.85%	Est @ 4.04%	Est @ 3.48%	Est @ 3.08%
Present Value (A$, Millions) Discounted @ 8.9%	AU$72.5	AU$66.1	AU$72.2	AU$65.2	AU$66.7	AU$64.9	AU$62.5	AU$59.7	AU$56.7	AU$53.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$640m

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$126m× (1 + 2.2%) ÷ (8.9%– 2.2%) = AU$1.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$1.9b÷ ( 1 + 8.9%)¹⁰= AU$810m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$1.5b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$10.3, the company appears about fair value at a 17% 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

Now 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 Collins Foods 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 8.9%, which is based on a levered beta of 1.470. 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 Collins Foods

Strength

• Debt is well covered by cash flow.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

• 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 Australian market.

• Current share price is below our estimate of fair value.

Threat

• Dividends are not covered by earnings.

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

Moving On:

Although the valuation of a company is important, it 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. 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 Collins Foods, we've put together three relevant aspects you should consider:

1. Risks: You should be aware of the 3 warning signs for Collins Foods (1 makes us a bit uncomfortable!) we've uncovered before considering an investment in the company.

2. Future Earnings: How does CKF'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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.