Premier Investments Limited's (ASX:PMV) Intrinsic Value Is Potentially 58% Above Its Share Price

Key Insights

• The projected fair value for Premier Investments is AU$21.17 based on 2 Stage Free Cash Flow to Equity
• Current share price of AU$13.42 suggests Premier Investments is potentially 37% undervalued
• Analyst price target for PMV is AU$18.72 which is 12% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Premier Investments Limited (ASX:PMV) by projecting its future cash flows and then 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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The Calculation

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (A$, Millions)	AU$174.8m	AU$191.3m	AU$189.8m	AU$190.6m	AU$193.1m	AU$196.8m	AU$201.4m	AU$206.7m	AU$212.5m	AU$218.8m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Est @ 0.46%	Est @ 1.31%	Est @ 1.91%	Est @ 2.33%	Est @ 2.62%	Est @ 2.82%	Est @ 2.97%
Present Value (A$, Millions) Discounted @ 8.2%	AU$162	AU$163	AU$150	AU$139	AU$130	AU$123	AU$116	AU$110	AU$104	AU$99.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.3b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 3.3%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = AU$219m× (1 + 3.3%) ÷ (8.2%– 3.3%) = AU$4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$4.6b÷ ( 1 + 8.2%)¹⁰= AU$2.1b

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$3.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$13.4, the company appears quite good value at a 37% 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.

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 Premier Investments 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 8.2%, which is based on a levered beta of 1.167. 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.

Check out our latest analysis for Premier Investments

SWOT Analysis for Premier Investments

Moving On:

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. 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. Why is the intrinsic value higher than the current share price? For Premier Investments, there are three essential factors you should further research:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Premier Investments , and understanding it should be part of your investment process.
2. Future Earnings: How does PMV'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 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. 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.