In this article we are going to estimate the intrinsic value of Superloop Limited (ASX:SLC) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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.
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) estimate
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (A$, Millions)
-AU$77.9m
AU$11.4m
AU$18.5m
AU$22.6m
AU$26.3m
AU$29.5m
AU$32.1m
AU$34.3m
AU$36.2m
AU$37.7m
Growth Rate Estimate Source
Est @ 31.18%
Analyst x1
Analyst x1
Est @ 22.41%
Est @ 16.26%
Est @ 11.96%
Est @ 8.95%
Est @ 6.85%
Est @ 5.37%
Est @ 4.34%
Present Value (A$, Millions) Discounted @ 6.7%
-AU$73.0
AU$10.0
AU$15.2
AU$17.5
AU$19.1
AU$20.0
AU$20.4
AU$20.5
AU$20.2
AU$19.8
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = AU$90m
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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 6.7%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$809m÷ ( 1 + 6.7%)10= AU$424m
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 AU$513m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.7, the company appears quite good value at a 34% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
ASX:SLC Discounted Cash Flow February 23rd 2023
The Assumptions
Now 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 these inputs, I recommend redoing the calculations yourself and playing with them. 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 Superloop 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 6.7%, which is based on a levered beta of 0.800. 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 Superloop
Strength
Debt is well covered by earnings.
Weakness
No major weaknesses identified for SLC.
Opportunity
Forecast to reduce losses next year.
Good value based on P/S ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Has less than 3 years of cash runway based on current free cash flow.
Next Steps:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Superloop, we've compiled three essential items you should further research:
Future Earnings: How does SLC'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 ASX every day. If you want to find the calculation for other stocks just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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