De La Rue's estimated fair value is UK£0.82 based on 2 Stage Free Cash Flow to Equity
Current share price of UK£1.03 suggests De La Rue is potentially 26% overvalued
Today we will run through one way of estimating the intrinsic value of De La Rue plc (LON:DLAR) 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. It may sound complicated, but actually it is quite simple!
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (£, Millions)
UK£7.40m
UK£8.70m
UK£9.65m
UK£10.4m
UK£11.1m
UK£11.6m
UK£12.1m
UK£12.5m
UK£12.9m
UK£13.2m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ 10.94%
Est @ 8.19%
Est @ 6.26%
Est @ 4.91%
Est @ 3.97%
Est @ 3.31%
Est @ 2.85%
Est @ 2.52%
Present Value (£, Millions) Discounted @ 8.4%
UK£6.8
UK£7.4
UK£7.6
UK£7.6
UK£7.4
UK£7.2
UK£6.9
UK£6.6
UK£6.2
UK£5.9
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK£70m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.4%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£203m÷ ( 1 + 8.4%)10= UK£91m
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£160m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.0, the company appears slightly overvalued 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.
LSE:DLAR Discounted Cash Flow July 27th 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. 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 De La Rue 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 8.4%, which is based on a levered beta of 1.206. 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 De La Rue
Strength
Debt is well covered by cash flow.
Weakness
Interest payments on debt are not well covered.
Opportunity
Expected to breakeven next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio compared to estimated Fair P/S ratio.
Threat
No apparent threats visible for DLAR.
Moving On:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. Can we work out why the company is trading at a premium to intrinsic value? For De La Rue, we've compiled three additional factors you should look at:
Future Earnings: How does DLAR'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE 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.
