Mainfreight Limited's (NZSE:MFT) Intrinsic Value Is Potentially 23% Below Its Share Price

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

Tue, Oct 24, 2023, 9:01 PM 6 min read

The Model

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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 (NZ$, Millions)	-NZ$93.6m	NZ$119.2m	NZ$86.1m	NZ$158.2m	NZ$213.6m	NZ$251.9m	NZ$285.3m	NZ$313.7m	NZ$337.8m	NZ$358.2m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 17.93%	Est @ 13.25%	Est @ 9.97%	Est @ 7.67%	Est @ 6.06%
Present Value (NZ$, Millions) Discounted @ 7.4%	-NZ$87.1	NZ$103	NZ$69.5	NZ$119	NZ$149	NZ$164	NZ$173	NZ$177	NZ$178	NZ$175

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$1.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$358m× (1 + 2.3%) ÷ (7.4%– 2.3%) = NZ$7.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$7.2b÷ ( 1 + 7.4%)¹⁰= NZ$3.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$4.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NZ$61.0, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf — NZSE:MFT Discounted Cash Flow October 25th 2023

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Mainfreight 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 7.4%, which is based on a levered beta of 1.020. 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 Mainfreight

Strength

Debt is not viewed as a risk.

Dividends are covered by earnings and cash flows.

Weakness

Earnings growth over the past year underperformed the Logistics industry.

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

Opportunity

Annual earnings are forecast to grow for the next 3 years.

Good value based on P/E ratio compared to estimated Fair P/E ratio.

Significant insider buying over the past 3 months.

Threat

Annual earnings are forecast to grow slower than the New Zealander market.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 exceeding the intrinsic value? For Mainfreight, we've compiled three essential factors you should look at:

Financial Health: Does MFT 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.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MFT's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 New Zealander 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.