Any chance at Smiths News plc (LON:SNWS) 50% undervaluation?

In this article, we’re going to estimate the intrinsic value of Smiths News plc (LON:SNWS) by taking its expected future cash flows and discounting them to their present value. The discounted cash flow (DCF) model is the tool we will use for this. Before you think you can’t get it, just keep reading! It’s actually a lot less complex than you might imagine.

We point out that there are many ways to value a company and, like DCF, each method has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, you can read the rationale for this calculation in detail in the Simply Wall St analysis model.

Check out our latest analysis for Smiths News

The calculation

We use what is called a 2-stage model, which simply means that we have two different growth rates for the company’s cash flows. In general, the first stage is higher growth and the second stage is lower growth phase. First, we need to get estimates of cash flows for the next ten years. Where possible we use analyst estimates, but when these are not available we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We expect companies with declining free cash flow to slow their rate of contraction and companies with growing free cash flow to slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less 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.

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Leveraged FCF (£, million)

UK £8.05m

UK £25.0m

UK £19.4m

UK £16.4m

UK £14.7m

UK £13.7m

UK £13.1m

UK £12.7m

UK £12.5m

UK £12.3m

Source of growth rate estimate

Analyst x2

Analyst x1

Estimated @ -22.32%

Estimated @ -15.33%

Estimated @ -10.43%

Estimated at -7%

Estimated @ -4.61%

Estimated @ -2.93%

Estimated @ -1.75%

Estimated @ -0.93%

Present Value (£,million) Discounted @ 9.0%

UK£7.4

UK£21.0

UK£15.0

UK£11.7

UK£9.6

UK£8.2

UK£7.2

UK£6.4

UK£5.7

UK£5.2

(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 97 million British pounds

The second stage is also known as the terminal value, this is the company’s cash flow after the first stage. A very conservative growth rate is used, which cannot exceed a country’s GDP growth, for a number of reasons. In this case, we have used the 5-year average of the 10-year government bond yield (1.0%) to estimate future growth. As with the 10-year “growth period,” we discount future cash flows to today’s value using a cost of equity rate of 9.0%.

final value (TV)= FCF2032 × (1 + g) ÷ (r – g) = £12 million × (1 + 1.0%) ÷ (9.0% – 1.0%) = £156 million

Present value of terminal value (PVTV)= TV / (1 + r)10= GB £156m ÷ (1 + 9.0%)10= 66 million British pounds

The total value is the sum of the cash flows for the next ten years plus the discounted future value, giving the total equity value, which in this case is £163 million. The final step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of £0.3, the company appears fairly cheap at a 50% discount to the current share price. The assumptions in each calculation have a big impact on the score, so it’s better to take this as a rough estimate, not accurate to the last penny.

DCF

Important Assumptions

The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. You do not have to agree with these inputs, I recommend repeating and playing with the calculations yourself. The DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs, so it does not provide a complete picture of a company’s potential performance. Because we view Smiths News as a potential shareholder, the discount rate used is the cost of equity rather than the cost of capital (or weighted average cost of capital, WACC), which accounts for debt. In this calculation we used 9.0% which is based on a leveraged beta of 1.497. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the industry average of global peers, with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Valuation is only one side of the coin when it comes to creating your investment thesis, and it’s just one of many factors you need to evaluate for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you would apply different cases and assumptions and see how they would affect the company’s valuation. If a company is growing at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome can be very different. Why is the intrinsic value higher than the current share price? For Smiths News, there are three important aspects to investigate:

  1. risks: Note that Smith’s News is displayed 5 warning signs in our investment analysis and 1 of them should not be ignored…

  2. future earnings: What is the growth rate of SNWS compared to its competitors and the broader market? Dive deeper into analyst consensus numbers for the years ahead by interacting with our free analyst growth expectations chart.

  3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of ​​what else you might be missing!

hp The Simply Wall St app performs a daily discounted cash flow valuation for each stock on the LSE. If you want to find the calculation for other stocks, just search here.

Do you have any feedback about this article? Concerned about the content? Get in touch directly with us. Alternatively, send an email to the editorial team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

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