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A Look At The Fair Value Of Viva Energy Group Limited (ASX:VEA)

Key Insights

  • Viva Energy Group's estimated fair value is AU$3.08 based on 2 Stage Free Cash Flow to Equity

  • With AU$2.88 share price, Viva Energy Group appears to be trading close to its estimated fair value

  • Analyst price target for VEA is AU$3.32, which is 7.7% above our fair value estimate

In this article we are going to estimate the intrinsic value of Viva Energy Group Limited (ASX:VEA) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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View our latest analysis for Viva Energy Group

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate 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, 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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$128.0m

AU$236.0m

AU$350.0m

AU$381.0m

AU$404.1m

AU$423.7m

AU$440.7m

AU$455.7m

AU$469.3m

AU$481.9m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Analyst x1

Est @ 6.07%

Est @ 4.85%

Est @ 4.00%

Est @ 3.40%

Est @ 2.98%

Est @ 2.69%

Present Value (A$, Millions) Discounted @ 9.7%

AU$117

AU$196

AU$265

AU$264

AU$255

AU$244

AU$231

AU$218

AU$205

AU$192

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$2.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 9.7%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$482m× (1 + 2.0%) ÷ (9.7%– 2.0%) = AU$6.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$6.4b÷ ( 1 + 9.7%)10= AU$2.6b

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$4.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$2.9, the company appears about fair value at a 6.6% discount to where the stock price trades currently. 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
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 Viva Energy 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 9.7%, which is based on a levered beta of 1.528. 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 Viva Energy Group

Strength

  • Debt is well covered by cash flow.

  • Dividend is in the top 25% of dividend payers in the market.

Weakness

  • Interest payments on debt are not well covered.

Opportunity

  • Expected to breakeven next year.

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

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

Threat

  • Dividends are not covered by cash flow.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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. 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 Viva Energy Group, we've put together three additional factors you should explore:

  1. Risks: Every company has them, and we've spotted 1 warning sign for Viva Energy Group you should know about.

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

  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.

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.