Today we'll do a simple run through of a valuation method used to estimate the attractiveness of oOh!media Limited (ASX:OML) as an investment opportunity 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.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (A$, Millions)
AU$35.9m
AU$55.2m
AU$66.2m
AU$71.0m
AU$77.0m
AU$81.5m
AU$85.4m
AU$88.9m
AU$92.0m
AU$94.9m
Growth Rate Estimate Source
Analyst x2
Analyst x2
Analyst x2
Analyst x1
Analyst x1
Est @ 5.89%
Est @ 4.80%
Est @ 4.04%
Est @ 3.50%
Est @ 3.13%
Present Value (A$, Millions) Discounted @ 7.5%
AU$33.3
AU$47.7
AU$53.2
AU$53.1
AU$53.5
AU$52.7
AU$51.4
AU$49.7
AU$47.8
AU$45.9
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = AU$488m
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. 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 (2.3%) 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%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$1.8b÷ ( 1 + 7.5%)10= AU$889m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$1.4b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.8, the company appears quite good value at a 32% 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.
ASX:OML Discounted Cash Flow May 9th 2024
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 oOh!media 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 1.147. 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 oOh!media
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by cash flow.
Dividends are covered by earnings and cash flows.
Weakness
Earnings growth over the past year is below its 5-year average.
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Media market.
Opportunity
Annual earnings are forecast to grow faster than the Australian market.
Trading below our estimate of fair value by more than 20%.
Threat
Annual revenue is forecast to grow slower than the Australian market.
Next Steps:
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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For oOh!media, we've put together three further items you should further research:
Risks: For example, we've discovered 1 warning sign for oOh!media that you should be aware of before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for OML'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 Australian 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.
