A Look At The Fair Value Of Elementis plc (LON:ELM)

Kyle Sanford

Sun, Feb 17, 2019, 10:16 PM

In this article I am going to calculate the intrinsic value of Elementis plc (LON:ELM) by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.

See our latest analysis for Elementis

Crunching the numbers

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF ($, Millions)	$80.90	$94.32	$114.10	$112.42	$110.76
Source	Analyst x4	Analyst x5	Analyst x1	Est @ -1.47%	Est @ -1.47%
Present Value Discounted @ 9.38%	$73.96	$78.84	$87.20	$78.55	$70.76

Present Value of 5-year Cash Flow (PVCF)= US$389m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.2%. We discount this to today’s value at a cost of equity of 9.4%.

Terminal Value (TV) = FCF₂₀₂₃ × (1 + g) ÷ (r – g) = US$111m × (1 + 1.2%) ÷ (9.4% – 1.2%) = US$1.4b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = US$1.4b ÷ ( 1 + 9.4%)⁵ = US$879m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$1.3b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of £1.7. Relative to the current share price of £1.96, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

LSE:ELM Intrinsic Value Export February 18th 19

Important assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Elementis as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.4%, which is based on a levered beta of 0.929. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For ELM, I’ve compiled three essential aspects you should further research:

Financial Health: Does ELM have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does ELM’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: Are there other high quality stocks you could be holding instead of ELM? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the LON every 6 hours. If you want to find the calculation for other stocks just search here.

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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.