Key Insights
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Using the 2 Stage Free Cash Flow to Equity, Mitchells & Butlers fair value estimate is UK£3.15
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Mitchells & Butlers' UK£2.54 share price indicates it is trading at similar levels as its fair value estimate
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The UK£3.49 analyst price target for MAB is 11% more than our estimate of fair value
Today we will run through one way of estimating the intrinsic value of Mitchells & Butlers plc ( LON:MAB ) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. 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 .
Is Mitchells & Butlers Fairly Valued?
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
| 2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
2034 |
2035 |
|
|---|---|---|---|---|---|---|---|---|---|---|
| Levered FCF (£, Millions) |
UK£121.9m |
UK£133.7m |
UK£153.7m |
UK£167.6m |
UK£179.8m |
UK£190.5m |
UK£200.2m |
UK£209.1m |
UK£217.5m |
UK£225.5m |
| Growth Rate Estimate Source |
Analyst x4 |
Analyst x4 |
Analyst x3 |
Est @ 9.06% |
Est @ 7.24% |
Est @ 5.97% |
Est @ 5.07% |
Est @ 4.45% |
Est @ 4.01% |
Est @ 3.70% |
| Present Value (£, Millions) Discounted @ 12% |
UK£109 |
UK£107 |
UK£111 |
UK£108 |
UK£104 |
UK£98.6 |
UK£92.8 |
UK£86.9 |
UK£81.0 |
UK£75.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF)= UK£974m
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 3.0%. We discount the terminal cash flows to today's value at a cost of equity of 12%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = UK£226m× (1 + 3.0%) ÷ (12%– 3.0%) = UK£2.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£2.7b÷ ( 1 + 12%)10= UK£900m
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£1.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.5, the company appears about fair value at a 19% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The 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. 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 Mitchells & Butlers 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 12%, which is based on a levered beta of 1.688. 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.
See our latest analysis for Mitchells & Butlers
SWOT Analysis for Mitchells & Butlers
Strength
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Earnings growth over the past year exceeded the industry.
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Debt is not viewed as a risk.
Weakness
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Earnings growth over the past year is below its 5-year average.
Opportunity
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Annual earnings are forecast to grow for the next 3 years.
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Good value based on P/E ratio and estimated fair value.
Threat
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Annual earnings are forecast to grow slower than the British market.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Mitchells & Butlers, we've compiled three additional elements you should further research:
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Financial Health: Does MAB have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
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Future Earnings: How does MAB'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 .
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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.
