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Estimating The Intrinsic Value Of Grit Real Estate Income Group Limited (LON:GR1T)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Grit Real Estate Income Group Limited (LON:GR1T) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Grit Real Estate Income Group

The Model

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. To begin with, we have to get estimates of 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.

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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$32.4m

US$33.4m

US$34.1m

US$34.8m

US$35.3m

US$35.8m

US$36.3m

US$36.7m

US$37.2m

US$37.6m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ 2.26%

Est @ 1.88%

Est @ 1.61%

Est @ 1.43%

Est @ 1.30%

Est @ 1.20%

Est @ 1.14%

Est @ 1.09%

Present Value ($, Millions) Discounted @ 18%

US$27.3

US$23.8

US$20.6

US$17.7

US$15.2

US$13.1

US$11.2

US$9.6

US$8.2

US$7.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$154m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.0%) 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 18%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$38m× (1 + 1.0%) ÷ (18%– 1.0%) = US$219m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$219m÷ ( 1 + 18%)10= US$41m

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$194m. 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£0.3, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
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. 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 Grit Real Estate Income 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 18%, which is based on a levered beta of 2.000. 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 Grit Real Estate Income Group

Strength

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

Weakness

  • Interest payments on debt are not well covered.

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

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

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by earnings and cashflows.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for 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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Grit Real Estate Income Group, we've compiled three fundamental factors you should look at:

  1. Risks: For example, we've discovered 4 warning signs for Grit Real Estate Income Group (2 are a bit unpleasant!) that you should be aware of before investing here.

  2. Future Earnings: How does GR1T'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.

  3. 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 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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