An Intrinsic Calculation For Premier Foods plc (LON:PFD) Suggests It's 49% Undervalued

Key Insights Premier Foods' estimated fair value is UK£3.55 based on 2 Stage Free Cash Flow to Equity Current share price of UK£1.79 suggests Premier Foods is potentially 49% undervalued is 45% less than our estimate of fair value How far off is Premier Foods plc ( ) 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.

Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple! Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the .



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 need to discount the sum of these future cash flows to arrive at a present value estimate: 10-year free cash flow (FCF) forecast UK£124.1m UK£117.6m UK£126.

1m UK£127.6m UK£129.4m UK£131.

4m UK£133.6m UK£135.9m UK£138.

4m UK£140.9m Analyst x3 Analyst x3 Analyst x3 Est @ 1.17% Est @ 1.

40% Est @ 1.56% Est @ 1.67% Est @ 1.

75% Est @ 1.80% Est @ 1.84% UK£117 UK£105 UK£106 UK£102 UK£97.

6 UK£93.6 UK£90.0 UK£86.

5 UK£83.2 UK£80.1 = UK£962m After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.

8%. = FCF × (1 + g) ÷ (r – g) = UK£141m× (1 + 1.9%) ÷ (5.

8%– 1.9%) = UK£3.7b = TV / (1 + r) = UK£3.

7b÷ ( 1 + 5.8%) = UK£2.1b The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£3.

1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£1.

8, the company appears quite good value at a 49% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Premier Foods 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 5.8%, which is based on a levered beta of 0.

800. 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 Premier Foods Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk. Earnings growth over the past year is below its 5-year average. Dividend is low compared to the top 25% of dividend payers in the Food market.

Annual earnings are forecast to grow for the next 3 years. Good value based on P/E ratio and estimated fair value. Annual earnings are forecast to grow slower than the British market.

Although the valuation of a company is important, it 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. What is the reason for the share price sitting below the intrinsic value? For Premier Foods, we've put together three relevant factors you should consider: : Does PFD have a healthy balance sheet? Take a look at our on key factors like leverage and risk. : How does PFD'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 .

: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore to see if there are other companies you may not have considered! PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just .

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