How far off is ASOS Plc (LON:ASC) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
Levered FCF (£, Millions)
-UK£23.5m
UK£138.8m
UK£182.5m
UK£250.5m
UK£312.0m
UK£356.8m
UK£393.7m
UK£423.3m
UK£446.7m
UK£465.2m
Growth Rate Estimate Source
Analyst x10
Analyst x12
Analyst x11
Analyst x2
Analyst x1
Est @ 14.37%
Est @ 10.33%
Est @ 7.51%
Est @ 5.53%
Est @ 4.15%
Present Value (£, Millions) Discounted @ 6.6%
-UK£22.1
UK£122
UK£151
UK£194
UK£227
UK£243
UK£252
UK£254
UK£252
UK£246
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK£1.9b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (0.9%) 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 6.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£8.3b÷ ( 1 + 6.6%)10= UK£4.4b
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£6.3b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£48.9, the company appears a touch undervalued at a 23% 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.
AIM:ASC Discounted Cash Flow June 29th 2021
Important 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 ASOS 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 1.066. 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.
Moving On:
Whilst important, the DCF calculation 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For ASOS, there are three further elements you should further examine:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ASC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. 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.
This article by Simply Wall St is general in nature. 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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