Key Insights

Viva Energy Group's estimated fair value is AU$3.08 based on 2 Stage Free Cash Flow to Equity With AU$2.71 share price, Viva Energy Group appears to be trading close to its estimated fair value Our fair value estimate is 14% lower than Viva Energy Group's analyst price target of AU$3.58

How far off is Viva Energy Group Limited (ASX:VEA) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Viva Energy Group

Crunching The Numbers

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (A$, Millions)  AU$382.4m AU$386.6m AU$402.5m AU$390.0m AU$384.9m AU$384.2m AU$386.4m AU$390.8m AU$396.8m AU$403.9m Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x2 Analyst x1 Est @ -1.30% Est @ -0.19% Est @ 0.59% Est @ 1.14% Est @ 1.52% Est @ 1.79% Present Value (A$, Millions) Discounted @ 9.4%  AU$350 AU$323 AU$308 AU$273 AU$246 AU$224 AU$206 AU$191 AU$177 AU$165

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$2.5b

Story Continues

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$404m× (1 + 2.4%) ÷ (9.4%– 2.4%) = AU$5.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$5.9b÷ ( 1 + 9.4%)10= AU$2.4b

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 AU$4.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$2.7, the company appears about fair value at a 12% 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.ASX:VEA Discounted Cash Flow October 28th 2024

The Assumptions

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 Viva Energy 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 9.4%, which is based on a levered beta of 1.689. 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 Viva Energy Group

Strength

Debt is well covered by cash flow.

Weakness

Interest payments on debt are not well covered.

Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.

Shareholders have been diluted in the past year.

Opportunity

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

Current share price is below our estimate of fair value.

Threat

Dividends are not covered by earnings.

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

Next Steps:

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. 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. For Viva Energy Group, we've compiled three essential aspects you should assess:

Risks: For example, we've discovered 5 warning signs for Viva Energy Group (1 shouldn't be ignored!) that you should be aware of before investing here. Future Earnings: How does VEA'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.

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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