Avingtrans plc (LON:AVG) Shares Could Be 34% Above Their Intrinsic Value Estimate

editorial-team@simplywallst.com (Simply Wall St)

Sun, Oct 13, 2024, 3:22 AM 6 min read

Does the October share price for Avingtrans plc (LON:AVG) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Avingtrans

Is Avingtrans Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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£4.95m	UK£3.79m	UK£4.52m	UK£5.15m	UK£5.69m	UK£6.14m	UK£6.51m	UK£6.83m	UK£7.10m	UK£7.34m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 19.28%	Est @ 14.08%	Est @ 10.43%	Est @ 7.88%	Est @ 6.10%	Est @ 4.85%	Est @ 3.97%	Est @ 3.36%
Present Value (£, Millions) Discounted @ 7.2%	-UK£4.6	UK£3.3	UK£3.7	UK£3.9	UK£4.0	UK£4.0	UK£4.0	UK£3.9	UK£3.8	UK£3.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£30m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£7.3m× (1 + 1.9%) ÷ (7.2%– 1.9%) = UK£142m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£142m÷ ( 1 + 7.2%)¹⁰= UK£71m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£100m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£4.1, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf — AIM:AVG Discounted Cash Flow October 13th 2024

Important 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 Avingtrans 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 7.2%, which is based on a levered beta of 1.090. 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 Avingtrans

Strength

Debt is well covered by earnings.

Weakness

Earnings declined over the past year.

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

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

Opportunity

Annual earnings are forecast to grow faster than the British market.

Threat

Debt is not well covered by operating cash flow.

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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For Avingtrans, we've put together three additional elements you should further research:

Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Avingtrans , and understanding it should be part of your investment process.
Future Earnings: How does AVG'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.
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.