Clean Power Hydrogen Plc (LON:CPH2) Shares Could Be 49% Below Their Intrinsic Value Estimate

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

Thu, May 23, 2024, 7:53 AM 6 min read

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Clean Power Hydrogen Plc (LON:CPH2) as an investment opportunity 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Clean Power Hydrogen

The 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 start off with, we need to estimate 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	-UK£11.5m	-UK£5.16m	UK£2.65m	UK£3.51m	UK£4.33m	UK£5.06m	UK£5.68m	UK£6.21m	UK£6.64m	UK£6.99m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x1	Est @ 32.61%	Est @ 23.36%	Est @ 16.88%	Est @ 12.35%	Est @ 9.17%	Est @ 6.95%	Est @ 5.40%
Present Value (£, Millions) Discounted @ 7.5%	-UK£10.7	-UK£4.5	UK£2.1	UK£2.6	UK£3.0	UK£3.3	UK£3.4	UK£3.5	UK£3.5	UK£3.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£9.7m

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 (1.8%) 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 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£7.0m× (1 + 1.8%) ÷ (7.5%– 1.8%) = UK£125m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£125m÷ ( 1 + 7.5%)¹⁰= UK£61m

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£70m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.1, the company appears quite undervalued at a 49% 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.

dcf — AIM:CPH2 Discounted Cash Flow May 23rd 2024

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 Clean Power Hydrogen 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 7.5%, which is based on a levered beta of 1.041. 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 Clean Power Hydrogen

Strength

Currently debt free.

Weakness

No major weaknesses identified for CPH2.

Opportunity

Trading below our estimate of fair value by more than 20%.

Threat

Has less than 3 years of cash runway based on current free cash flow.

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. It's not possible to obtain a foolproof valuation with a DCF model. 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. Can we work out why the company is trading at a discount to intrinsic value? For Clean Power Hydrogen, we've put together three essential factors you should further examine:

Risks: Take risks, for example - Clean Power Hydrogen has 6 warning signs (and 4 which are a bit concerning) we think you should know about.
Future Earnings: How does CPH2'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. 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.