The projected fair value for Dollar General is US$182 based on 2 Stage Free Cash Flow to Equity
Dollar General is estimated to be 28% undervalued based on current share price of US$130
Our fair value estimate is 22% higher than Dollar General's analyst price target of US$149
Does the June share price for Dollar General Corporation (NYSE:DG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF ($, Millions)
US$723.3m
US$1.39b
US$1.52b
US$1.66b
US$1.90b
US$2.00b
US$2.07b
US$2.15b
US$2.21b
US$2.28b
Growth Rate Estimate Source
Analyst x7
Analyst x7
Analyst x6
Analyst x5
Analyst x2
Analyst x2
Est @ 3.93%
Est @ 3.47%
Est @ 3.14%
Est @ 2.91%
Present Value ($, Millions) Discounted @ 6.7%
US$678
US$1.2k
US$1.2k
US$1.3k
US$1.4k
US$1.3k
US$1.3k
US$1.3k
US$1.2k
US$1.2k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$12b
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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$54b÷ ( 1 + 6.7%)10= US$28b
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$40b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$130, the company appears a touch undervalued at a 28% 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.
NYSE:DG Discounted Cash Flow June 25th 2024
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. 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 Dollar General 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 6.7%, which is based on a levered beta of 0.947. 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 Dollar General
Strength
Debt is well covered by earnings and cashflows.
Dividends are covered by earnings and cash flows.
Dividend information for DG.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Threat
Annual earnings are forecast to grow slower than the American market.
What else are analysts forecasting for DG?
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. Why is the intrinsic value higher than the current share price? For Dollar General, there are three important aspects you should explore:
Risks: To that end, you should be aware of the 4 warning signs we've spotted with Dollar General .
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 NYSE 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
