NASDAQ:DENN) by estimating the company’s future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!” data-reactid=”28″>In this article we are going to estimate the intrinsic value of Denny’s Corporation (NASDAQ:DENN) by estimating the company’s future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Simply Wall St analysis model here may be something of interest to you.” data-reactid=”29″>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.
Check out our latest analysis for Denny’s ” data-reactid=”30″> Check out our latest analysis for Denny’s
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$42.7m||US$52.5m||US$59.8m||US$66.0m||US$71.3m||US$75.7m||US$79.5m||US$82.9m||US$85.8m||US$88.6m|
|Growth Rate Estimate Source||Analyst x3||Analyst x3||Est @ 13.91%||Est @ 10.4%||Est @ 7.95%||Est @ 6.23%||Est @ 5.03%||Est @ 4.18%||Est @ 3.6%||Est @ 3.18%|
|Present Value ($, Millions) Discounted @ 11%||US$38.4||US$42.5||US$43.6||US$43.3||US$42.0||US$40.2||US$37.9||US$35.6||US$33.1||US$30.8|
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 11%.
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$739m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$10.6, the company appears about fair value at a 8.4% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Denny’s 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 11%, which is based on a levered beta of 1.486. 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.
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It’s not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Denny’s, we’ve put together three essential factors you should further research:
- Risks: Consider for instance, the ever-present spectre of investment risk. We’ve identified 4 warning signs with Denny’s (at least 2 which are concerning) , and understanding them should be part of your investment process.
- Future Earnings: How does DENN’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!
search here.” data-reactid=”70″>PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
Get in touch with us directly. Alternatively, email [email protected].” data-reactid=”71″>This article by Simply Wall St is general in nature. 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.