Key Insights

Using the 2 Stage Free Cash Flow to Equity, Kingfisher fair value estimate is UK£2.39 Current share price of UK£2.24 suggests Kingfisher is potentially trading close to its fair value Analyst price target for KGF is UK£2.26 which is 5.3% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Kingfisher plc (LON:KGF) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Kingfisher

What's The Estimated Valuation?

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. To start off with, we need to estimate the next ten years of cash flows. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (£, Millions)  UK£469.6m UK£361.1m UK£350.2m UK£345.1m UK£343.2m UK£343.6m UK£345.6m UK£348.7m UK£352.6m UK£357.1m Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Est @ -1.47% Est @ -0.54% Est @ 0.12% Est @ 0.57% Est @ 0.89% Est @ 1.12% Est @ 1.27% Present Value (£, Millions) Discounted @ 8.9%  UK£431 UK£304 UK£271 UK£245 UK£224 UK£205 UK£190 UK£176 UK£163 UK£152

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£2.4b



The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£357m× (1 + 1.6%) ÷ (8.9%– 1.6%) = UK£5.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£5.0b÷ ( 1 + 8.9%)10= UK£2.1b

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£4.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.2, the company appears about fair value at a 6.4% 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. dcf

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Kingfisher 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 8.9%, which is based on a levered beta of 1.334. 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 Kingfisher

Strength

Debt is not viewed as a risk.

Dividends are covered by earnings and cash flows.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.

Opportunity

Annual earnings are forecast to grow for the next 4 years.

Good value based on P/E ratio and estimated fair value.

Threat

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

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Kingfisher, we've compiled three additional factors you should assess:

Risks: Consider for instance, the ever-present spectre of investment risk.  We've identified 3 warning signs  with Kingfisher , and understanding these should be part of your investment process. Future Earnings: How does KGF'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.

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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.