Trajan Group Holdings Limited (ASX:TRJ) Shares Could Be 35% Below Their Intrinsic Value Estimate
Simply Wall St
6 min read
Does the February share price for Trajan Group Holdings Limited (ASX:TRJ) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis 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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (A$, Millions)
AU$17.6m
AU$15.1m
AU$19.1m
AU$22.0m
AU$24.6m
AU$26.7m
AU$28.5m
AU$30.0m
AU$31.3m
AU$32.4m
Growth Rate Estimate Source
Analyst x2
Analyst x2
Analyst x2
Est @ 15.70%
Est @ 11.57%
Est @ 8.68%
Est @ 6.65%
Est @ 5.24%
Est @ 4.24%
Est @ 3.55%
Present Value (A$, Millions) Discounted @ 7.9%
AU$16.3
AU$12.9
AU$15.2
AU$16.3
AU$16.8
AU$16.9
AU$16.7
AU$16.3
AU$15.8
AU$15.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = AU$158m
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 7.9%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$553m÷ ( 1 + 7.9%)10= AU$259m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$417m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.8, the company appears quite undervalued at a 35% discount to where the stock price trades currently. 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.
ASX:TRJ Discounted Cash Flow February 18th 2023
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Trajan Group Holdings 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 7.9%, which is based on a levered beta of 1.005. 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 Trajan Group Holdings
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the Australian market.
Good value based on P/S ratio and estimated fair value.
Significant insider buying over the past 3 months.
Threat
Debt is not well covered by operating cash flow.
Moving On:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. 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. Why is the intrinsic value higher than the current share price? For Trajan Group Holdings, we've put together three essential factors you should look at:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TRJ'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 Australian stock every day, so if you want to find the intrinsic value of any other stock 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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