Estimating The Intrinsic Value Of Virgin Wines UK PLC (LON:VINO)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Virgin Wines UK fair value estimate is UK£0.37

• Virgin Wines UK's UK£0.45 share price indicates it is trading at similar levels as its fair value estimate

• Virgin Wines UK's peers are currently trading at a discount of 39% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Virgin Wines UK PLC (LON:VINO) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Virgin Wines UK

Crunching The Numbers

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.

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£2.00m	UK£1.58m	UK£1.68m	UK£1.32m	UK£1.12m	UK£1.01m	UK£949.2k	UK£912.3k	UK£892.4k	UK£883.5k
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -21.77%	Est @ -14.71%	Est @ -9.76%	Est @ -6.30%	Est @ -3.88%	Est @ -2.19%	Est @ -1.00%
Present Value (£, Millions) Discounted @ 6.2%	UK£1.9	UK£1.4	UK£1.4	UK£1.0	UK£0.8	UK£0.7	UK£0.6	UK£0.6	UK£0.5	UK£0.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£9.5m

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 (1.8%) 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 6.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£883k× (1 + 1.8%) ÷ (6.2%– 1.8%) = UK£21m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£21m÷ ( 1 + 6.2%)¹⁰= UK£11m

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£21m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.4, the company appears around fair value at the time of writing. 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.

dcf

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 Virgin Wines UK 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 6.2%, 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 Virgin Wines UK

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

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

Opportunity

• Annual revenue is forecast to grow faster than the British market.

Threat

• No apparent threats visible for VINO.

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. 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 Virgin Wines UK, we've put together three relevant items you should assess:

1. Risks: You should be aware of the 4 warning signs for Virgin Wines UK (1 is potentially serious!) we've uncovered before considering an investment in the company.

2. Future Earnings: How does VINO'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 AIM 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com