In this article we are going to estimate the intrinsic value of Propel Funeral Partners Limited (ASX:PFP) 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. There's really not all that much to it, even though it might appear quite complex.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (A$, Millions)
AU$16.3m
AU$27.0m
AU$29.9m
AU$32.5m
AU$34.5m
AU$36.0m
AU$37.4m
AU$38.6m
AU$39.8m
AU$40.9m
Growth Rate Estimate Source
Analyst x3
Analyst x3
Analyst x3
Analyst x1
Analyst x1
Est @ 4.48%
Est @ 3.79%
Est @ 3.30%
Est @ 2.96%
Est @ 2.72%
Present Value (A$, Millions) Discounted @ 6.5%
AU$15.3
AU$23.8
AU$24.7
AU$25.2
AU$25.1
AU$24.7
AU$24.0
AU$23.3
AU$22.5
AU$21.7
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = AU$230m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$954m÷ ( 1 + 6.5%)10= AU$506m
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$737m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$5.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
dcf
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Propel Funeral Partners 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 6.5%, which is based on a levered beta of 0.952. 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 Propel Funeral Partners
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Consumer Services market.
Expensive based on P/E ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the Australian market.
Threat
Debt is not well covered by operating cash flow.
Dividends are not covered by earnings and cashflows.
Revenue is forecast to grow slower than 20% per year.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Propel Funeral Partners, we've put together three important items you should look at:
Future Earnings: How does PFP'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.
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks 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.
