Key Insights

Using the 2 Stage Free Cash Flow to Equity, National Grid fair value estimate is UK£11.30 With UK£10.68 share price, National Grid appears to be trading close to its estimated fair value Industry average discount to fair value of 5.7% suggests National Grid's peers are currently trading at a higher discount

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In this article we are going to estimate the intrinsic value of National Grid plc (LON:NG.) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

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What's The Estimated Valuation?

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.

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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (£, Millions)  -UK£3.28b UK£901.8m UK£1.26b UK£1.64b UK£2.03b UK£2.44b UK£2.75b UK£3.01b UK£3.24b UK£3.43b Growth Rate Estimate Source Analyst x3 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 12.58% Est @ 9.57% Est @ 7.46% Est @ 5.98% Present Value (£, Millions) Discounted @ 6.6%  -UK£3.1k UK£793 UK£1.0k UK£1.3k UK£1.5k UK£1.7k UK£1.8k UK£1.8k UK£1.8k UK£1.8k

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

Story Continues

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£3.4b× (1 + 2.5%) ÷ (6.6%– 2.5%) = UK£86b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£86b÷ ( 1 + 6.6%)10= UK£45b

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£55b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£10.7, the company appears about fair value at a 5.5% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.LSE:NG. Discounted Cash Flow June 25th 2025

The Assumptions

Now 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 National Grid 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 6.6%, 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.

See our latest analysis for National Grid

SWOT Analysis for National Grid

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by earnings.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.

Opportunity

Current share price is below our estimate of fair value.

Lack of analyst coverage makes it difficult to determine NG.'s earnings prospects.

Threat

Debt is not well covered by operating cash flow.

Paying a dividend but company has no free cash flows.

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 National Grid, there are three pertinent items you should further examine:

Risks: We feel that you should assess the 2 warning signs for National Grid (1 is a bit unpleasant!) we've flagged before making an investment in the company. 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! Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

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