The projected fair value for Eagle Eye Solutions Group is UK£5.40 based on 2 Stage Free Cash Flow to Equity
Current share price of UK£5.50 suggests Eagle Eye Solutions Group is potentially trading close to its fair value
Peers of Eagle Eye Solutions Group are currently trading on average at a 34% discount
In this article we are going to estimate the intrinsic value of Eagle Eye Solutions Group plc (LON:EYE) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
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)
UK£3.90m
UK£6.70m
UK£7.79m
UK£8.71m
UK£9.46m
UK£10.1m
UK£10.6m
UK£11.0m
UK£11.3m
UK£11.6m
Growth Rate Estimate Source
Analyst x2
Analyst x2
Est @ 16.31%
Est @ 11.79%
Est @ 8.63%
Est @ 6.41%
Est @ 4.86%
Est @ 3.77%
Est @ 3.01%
Est @ 2.48%
Present Value (£, Millions) Discounted @ 7.2%
UK£3.6
UK£5.8
UK£6.3
UK£6.6
UK£6.7
UK£6.6
UK£6.5
UK£6.3
UK£6.0
UK£5.8
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK£60m
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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£196m÷ ( 1 + 7.2%)10= UK£98m
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£158m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£5.5, the company appears around fair value 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.
AIM:EYE Discounted Cash Flow July 26th 2023
The 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 Eagle Eye Solutions Group 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 0.857. 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 Eagle Eye Solutions Group
Strength
Debt is not viewed as a risk.
Weakness
Earnings growth over the past year underperformed the Media industry.
Expensive based on P/S ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the British market.
Threat
No apparent threats visible for EYE.
Moving On:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. 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 Eagle Eye Solutions Group, we've compiled three pertinent aspects you should further examine:
Future Earnings: How does EYE'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 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.
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.
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