Estimating The Fair Value Of Revolution Bars Group plc (LON:RBG)

Key Insights

• Revolution Bars Group's estimated fair value is UK£0.015 based on 2 Stage Free Cash Flow to Equity

• Revolution Bars Group's UK£0.017 share price indicates it is trading at similar levels as its fair value estimate

• Revolution Bars Group's peers seem to be trading at a lower premium to fair value based onthe industry average of -16%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Revolution Bars Group plc (LON:RBG) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing 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 Revolution Bars Group

Is Revolution Bars Group 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. 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£500.0k	UK£800.0k	UK£1.30m	UK£563.6k	UK£342.9k	UK£250.6k	UK£204.6k	UK£179.3k	UK£164.7k	UK£156.1k
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -56.64%	Est @ -39.16%	Est @ -26.92%	Est @ -18.35%	Est @ -12.35%	Est @ -8.16%	Est @ -5.22%
Present Value (£, Millions) Discounted @ 13%	UK£0.4	UK£0.6	UK£0.9	UK£0.4	UK£0.2	UK£0.1	UK£0.09	UK£0.07	UK£0.06	UK£0.05

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£2.9m

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£156k× (1 + 1.6%) ÷ (13%– 1.6%) = UK£1.4m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£1.4m÷ ( 1 + 13%)¹⁰= UK£442k

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£3.4m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.02, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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 Revolution Bars 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 13%, which is based on a levered beta of 2.000. 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 Revolution Bars Group

Strength

• Debt is well covered by cash flow.

Weakness

• Interest payments on debt are not well covered.

Opportunity

• Forecast to reduce losses next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

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

Threat

• Total liabilities exceed total assets, which raises the risk of financial distress.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Revolution Bars Group, we've put together three relevant elements you should consider:

1. Risks: We feel that you should assess the 3 warning signs for Revolution Bars Group we've flagged before making an investment in the company.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for RBG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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 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.