Today we will run through one way of estimating the intrinsic value of NIOX Group Plc (LON:NIOX) by projecting its future cash flows and then discounting them to today's 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!
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.
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, 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
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (£, Millions)
UK£13.7m
UK£16.3m
UK£17.8m
UK£19.0m
UK£20.0m
UK£20.9m
UK£21.7m
UK£22.4m
UK£23.0m
UK£23.6m
Growth Rate Estimate Source
Analyst x3
Analyst x3
Est @ 8.79%
Est @ 6.78%
Est @ 5.38%
Est @ 4.40%
Est @ 3.71%
Est @ 3.23%
Est @ 2.90%
Est @ 2.66%
Present Value (£, Millions) Discounted @ 6.6%
UK£12.9
UK£14.4
UK£14.7
UK£14.7
UK£14.5
UK£14.2
UK£13.8
UK£13.4
UK£12.9
UK£12.5
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK£138m
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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£536m÷ ( 1 + 6.6%)10= UK£283m
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£421m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.7, the company appears quite undervalued at a 38% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
AIM:NIOX Discounted Cash Flow November 19th 2024
Important 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 NIOX Group 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 6.6%, which is based on a levered beta of 0.928. 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 NIOX Group
Strength
Currently debt free.
Dividends are covered by earnings and cash flows.
Weakness
Earnings growth over the past year underperformed the Medical Equipment industry.
Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.
Opportunity
Annual earnings are forecast to grow faster than the British market.
Good value based on P/E ratio and estimated fair value.
Threat
Revenue is forecast to grow slower than 20% per year.
Next Steps:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For NIOX Group, we've compiled three additional items you should assess:
Future Earnings: How does NIOX'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: 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM 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.
