Is Viva Leisure Limited (ASX:VVA) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

• Viva Leisure's estimated fair value is AU$1.17 based on 2 Stage Free Cash Flow to Equity

• Viva Leisure is estimated to be 22% overvalued based on current share price of AU$1.43

• Analyst price target for VVA is AU$2.70, which is 131% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Viva Leisure Limited (ASX:VVA) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Viva Leisure

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$10.5m	AU$23.7m	AU$16.5m	AU$13.7m	AU$12.1m	AU$11.2m	AU$10.7m	AU$10.5m	AU$10.4m	AU$10.4m
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Est @ -17.15%	Est @ -11.33%	Est @ -7.25%	Est @ -4.40%	Est @ -2.40%	Est @ -1.00%	Est @ -0.02%
Present Value (A$, Millions) Discounted @ 11%	AU$9.4	AU$19.1	AU$11.9	AU$8.9	AU$7.0	AU$5.9	AU$5.0	AU$4.4	AU$3.9	AU$3.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$79m

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 2.3%. 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) = AU$10m× (1 + 2.3%) ÷ (11%– 2.3%) = AU$115m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$115m÷ ( 1 + 11%)¹⁰= AU$39m

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 AU$118m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.4, the company appears slightly overvalued at the time of writing. 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.

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Viva Leisure 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 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 Viva Leisure

Strength

• Debt is well covered by cash flow.

Weakness

• Interest payments on debt are not well covered.

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

• Shareholders have been diluted in the past year.

Opportunity

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

Threat

• Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Viva Leisure, we've compiled three additional elements you should assess:

1. Risks: For example, we've discovered 2 warning signs for Viva Leisure that you should be aware of before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for VVA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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 ASX 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.

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