A Look At The Fair Value Of AB Dynamics plc (LON:ABDP)

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

Mon, Dec 16, 2024, 10:42 PM 6 min read

In this article we are going to estimate the intrinsic value of AB Dynamics plc (LON:ABDP) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for AB Dynamics

Is AB Dynamics Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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£15.9m	UK£17.0m	UK£20.1m	UK£20.5m	UK£20.9m	UK£21.3m	UK£21.8m	UK£22.2m	UK£22.7m	UK£23.1m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Est @ 1.95%	Est @ 2.00%	Est @ 2.03%	Est @ 2.05%	Est @ 2.07%	Est @ 2.08%	Est @ 2.09%
Present Value (£, Millions) Discounted @ 7.0%	UK£14.8	UK£14.9	UK£16.4	UK£15.6	UK£14.9	UK£14.2	UK£13.5	UK£12.9	UK£12.3	UK£11.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£141m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£23m× (1 + 2.1%) ÷ (7.0%– 2.1%) = UK£479m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£479m÷ ( 1 + 7.0%)¹⁰= UK£242m

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£384m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£19.2, 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.

dcf — AIM:ABDP Discounted Cash Flow December 17th 2024

The 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 AB Dynamics 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 7.0%, which is based on a levered beta of 1.017. 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 AB Dynamics

Strength

Currently debt free.

Weakness

Earnings declined over the past year.

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

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

Opportunity

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

Threat

Revenue is forecast to grow slower than 20% per year.

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. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 AB Dynamics, we've put together three essential factors you should consider:

Risks: Case in point, we've spotted 1 warning sign for AB Dynamics you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ABDP'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 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.