Yahoo Finance A Look At The Fair Value Of Hercules Site Services Plc (LON:HERC)
Key Insights
Hercules Site Services' estimated fair value is UK£0.30 based on 2 Stage Free Cash Flow to Equity
Hercules Site Services' UK£0.33 share price indicates it is trading at similar levels as its fair value estimate
The UK£0.63 analyst price target for HERC is 113% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hercules Site Services Plc (LON:HERC) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Hercules Site Services
What's The Estimated Valuation?
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. 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.
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
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (£, Millions) | UK£223.5k | UK£2.14m | UK£2.10m | UK£2.09m | UK£2.09m | UK£2.10m | UK£2.12m | UK£2.14m | UK£2.17m | UK£2.20m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x1 | Est @ -0.62% | Est @ 0.06% | Est @ 0.53% | Est @ 0.87% | Est @ 1.10% | Est @ 1.26% | Est @ 1.37% |
Present Value (£, Millions) Discounted @ 11% | UK£0.2 | UK£1.7 | UK£1.5 | UK£1.4 | UK£1.2 | UK£1.1 | UK£1.0 | UK£0.9 | UK£0.8 | UK£0.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£11m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 11%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£2.2m× (1 + 1.6%) ÷ (11%– 1.6%) = UK£23m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£23m÷ ( 1 + 11%)10= UK£8.2m
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£19m. 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.
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 Hercules Site Services 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 11%, which is based on a levered beta of 1.735. 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 Hercules Site Services
Strength
Earnings growth over the past year exceeded the industry.
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 Construction market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual revenue is forecast to grow faster than the British market.
Threat
Dividends are not covered by earnings.
Annual earnings are forecast to grow slower than the British market.
Next Steps:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Hercules Site Services, we've compiled three additional aspects you should explore:
Risks: You should be aware of the 3 warning signs for Hercules Site Services (1 shouldn't be ignored!) we've uncovered before considering an investment in the company.
Future Earnings: How does HERC'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. 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 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.
