A Look At The Intrinsic Value Of FFI Holdings Limited (ASX:FFI)

Key Insights

• FFI Holdings' estimated fair value is AU$6.51 based on 2 Stage Free Cash Flow to Equity

• FFI Holdings' AU$5.25 share price indicates it is trading at similar levels as its fair value estimate

• Industry average discount to fair value of 48% suggests FFI Holdings' peers are currently trading at a higher discount

In this article we are going to estimate the intrinsic value of FFI Holdings Limited (ASX:FFI) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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.

See our latest analysis for FFI Holdings

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$2.40m	AU$2.58m	AU$2.74m	AU$2.87m	AU$2.98m	AU$3.08m	AU$3.17m	AU$3.26m	AU$3.34m	AU$3.42m
Growth Rate Estimate Source	Est @ 10.12%	Est @ 7.68%	Est @ 5.98%	Est @ 4.79%	Est @ 3.96%	Est @ 3.37%	Est @ 2.96%	Est @ 2.68%	Est @ 2.48%	Est @ 2.34%
Present Value (A$, Millions) Discounted @ 6.0%	AU$2.3	AU$2.3	AU$2.3	AU$2.3	AU$2.2	AU$2.2	AU$2.1	AU$2.0	AU$2.0	AU$1.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$22m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$3.4m× (1 + 2.0%) ÷ (6.0%– 2.0%) = AU$87m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$87m÷ ( 1 + 6.0%)¹⁰= AU$49m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is AU$70m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$5.3, the company appears about fair value at a 19% 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. 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 FFI Holdings 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 6.0%, 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 FFI Holdings

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

• Dividends are covered by earnings and cash flows.

Weakness

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

Opportunity

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

• Lack of analyst coverage makes it difficult to determine FFI's earnings prospects.

Threat

• No apparent threats visible for FFI.

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For FFI Holdings, we've compiled three further aspects you should assess:

1. Risks: We feel that you should assess the 2 warning signs for FFI Holdings (1 is concerning!) we've flagged before making an investment in the company.

2. 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!

3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.