Key Insights

The projected fair value for Bakkavor Group is UK£1.35 based on 2 Stage Free Cash Flow to Equity Bakkavor Group is estimated to be 24% undervalued based on current share price of UK£1.03 Analyst price target for BAKK is UK£1.05 which is 22% below our fair value estimate

How far off is Bakkavor Group plc (LON:BAKK) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

View our latest analysis for Bakkavor Group

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (£, Millions)  UK£64.4m UK£57.0m UK£51.4m UK£49.2m UK£47.9m UK£47.1m UK£46.8m UK£46.7m UK£46.8m UK£47.1m Growth Rate Estimate Source Analyst x3 Analyst x4 Analyst x3 Est @ -4.28% Est @ -2.65% Est @ -1.51% Est @ -0.71% Est @ -0.15% Est @ 0.24% Est @ 0.51% Present Value (£, Millions) Discounted @ 7.0%  UK£60.2 UK£49.8 UK£42.0 UK£37.6 UK£34.2 UK£31.5 UK£29.2 UK£27.3 UK£25.6 UK£24.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£361m

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 (1.2%) 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 7.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£47m× (1 + 1.2%) ÷ (7.0%– 1.2%) = UK£821m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£821m÷ ( 1 + 7.0%)10= UK£419m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£781m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.0, the company appears a touch undervalued at a 24% 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. dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Bakkavor Group 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 7.0%, which is based on a levered beta of 0.832. 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 Bakkavor Group

Strength

Debt is well covered by earnings and cashflows.

Dividend is in the top 25% of dividend payers in the market.

Weakness

Earnings declined over the past year.

Opportunity

Annual earnings are forecast to grow faster than the British market.

Trading below our estimate of fair value by more than 20%.

Threat

Dividends are not covered by earnings.

Annual revenue is forecast to grow slower than the British market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Bakkavor Group, we've compiled three essential aspects you should look at:

Risks: Every company has them, and we've spotted  4 warning signs for Bakkavor Group  you should know about. Future Earnings: How does BAKK'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 LSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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