In this article I am going to calculate the intrinsic value of Investore Property Limited (NZSE:IPL) by taking the expected future cash flows and discounted them to the value today. Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity by taking the expected Future Cash Flows and discounting them to their present value. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2017 then I highly recommend you check out the latest calculation for Investore Property by following the link below. See our latest analysis for IPL
I use what is known as a 2-stage model, which simply means we have two different periods where we need to estimate cash flows. To start off with we need to estimate the next 5 years of cash flows, seeing as no analyst estimates of Free Cash Flow are available I have extrapolated the most recent reported Free Cash Flow (FCF) based on the average annual revenue growth over the past 5 years. I then discount the sum of these cash flows to arrive at a present value estimate.
Step by step through the calculation
Note the numbers here are in millions apart from the per share values.
5-year cash flow estimate
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (NZD, Millions) | $0.00 | $0.00 | $0.00 | $0.00 | $0.00 |
Source | Extrapolated @ (20%, capped from 83.16%) | Extrapolated @ (19%, capped from 83.16%) | Extrapolated @ (18%, capped from 83.16%) | Extrapolated @ (17%, capped from 83.16%) | Extrapolated @ (16%, capped from 83.16%) |
Present Value Discounted @ 8.55% | $0.00 | $0.00 | $0.00 | $0.00 | $0.00 |
Present value of next 5 years cash flows: $0
After calculating the present value of cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the 1st stage. For a number of reasons a very conservative rate is used that cannot exceed that of the GDP. In this case I have used the 10 year government bond rate (2.8%). In the same way as with the 5 year ‘growth’ period we discount this to today’s value.
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $0 × (1 + 2.8%) ÷ (8.6% – 2.8%)
Terminal value based on the Perpetuity Method where growth (g) = 2.8%: $0
Present value of terminal value: $0
The total value or equity value is then the sum of of the present value of the cash flows.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $0 + $0 = $0
In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number.
Value = Total value / Shares Outstanding ($0.00 / 261.77)
Finally if we compare the intrinsic value of $0 to the current share price of $1.33 we see Investore Property (NZSE:IPL) is about right, maybe slightly undervalued at a 0.85% discount to what it is available for right now.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Investore Property as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 8.6% and this is based on a Levered Beta of 0.8. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business.
Conclusion
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Investore Property in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
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