Are Investors Undervaluing ITV plc (LON:ITV) By 33%?
How far is ITV plc (LON: ITV) from its intrinsic value? Using the latest financial data, we check if the stock is reasonably priced by estimating the company's future cash flows and discounting them to their present value. We use the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow as you will see from our example!
We point out that there are many ways to rate a company and, like with DCF, each technique has advantages and disadvantages in certain scenarios. For those familiar with stock research, the Simply Wall St analysis model might be of interest here.
Check out our latest analysis for ITV
We will be using a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that flattens out towards the terminal value and is recorded in the second phase of "steady growth". First, we need to get estimates of the next ten years of cash flow. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the early years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today's value:
10-year free cash flow forecast (FCF)
Leverage FCF (£, million)
UK £ 309.5m
UK £ 373.0m
UK £ 346.0m
UK £ 316.0m
UK £ 316.7m
UK £ 318.3m
UK £ 320.6m
UK £ 323.4m
UK £ 326.5m
UK £ 330.0m
Source for growth rate estimation
Est @ 0.21%
Est @ 0.51%
Est @ 0.72%
Est @ 0.87%
Est @ 0.98%
Est @ 1.05%
Present Value (£, Millions) Discounted 7.9%
UK £ 287
UK £ 320
UK £ 275
UK £ 233
UK £ 216
UK £ 201
UK £ 188
UK £ 176
UK £ 164
UK £ 154
("Est" = FCF growth rate, estimated by Simply Wall St)
Present Value of 10 Year Cash Flow (PVCF) = UK £ 2.2bn
After calculating the present value of future cash flows in the first 10 years, we need to calculate the terminal value that takes into account all future cash flows beyond the first stage. A very conservative growth rate is used that cannot exceed that of any country's GDP growth for a number of reasons. In this case, we used the 5-year average 10-year government bond yield (1.2%) to estimate future growth. Similar to the 10-year growth phase, we discount future cash flows to today's value using a cost of equity rate of 7.9%.
End value (TV) = FCF2030 × (1 + g) ÷ (r - g) = UK £ 330 million × (1 + 1.2%) ÷ (7.9% - 1.2%) = UK £ 5, 0b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = UK £ 5.0bn ÷ (1 + 7.9%) 10 = UK £ 2.3bn
The total or equity value is then the sum of the present value of the future cash flows, which in this case is £ 4.5 billion. To get the intrinsic value per share, we divide this by the total number of shares issued. Compared to the current UK share price of £ 0.8, the company appears to be doing reasonably well at a 33% discount to the current share price. The assumptions in any calculation have a huge impact on the valuation, so it is better to think of this as a rough estimate that is not accurate to the last cent.
We would like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of the investment is making your own assessment of a company's future performance. So try the calculation yourself and check your own assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company's potential performance. Given that we view ITV as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or the weighted average cost of capital, WACC) responsible for debt. In this calculation we used 7.9% based on a leverage beta of 0.969. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While evaluating a company is important, it is just one of many factors that you need to evaluate for a company. The DCF model is not a perfect tool for stock valuation. Rather, it should be seen as a guide to "what assumptions must be made for this stock to be undervalued or overvalued?" If a company is growing at a different rate, or if the cost of equity or the risk-free rate changes dramatically, performance can look very different. Can we find out why the company is trading at a discount on intrinsic value? For ITV, there are three main points to be aware of:
Risks: Take Risks, for example - ITV has 3 warning signs that we think you should be aware of.
Future Outcome: What is ITV's growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you might not have considered!
PS. The Simply Wall St app performs a discounted cash flow assessment for every share on the LSE every day. If you want to find the calculation for other stocks, just search here.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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