How far off is Mainfreight (NZSE:MFT) to its intrinsic value? I am going to take a look now by estimating the Future Cash Flows and discounting them to their present value. A discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows to a stock. It sounds complicated, but actually it is quite simple!
Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Please also note that this article was written in March 2017 so be sure check out the updated calculation by following the link below. Check out our latest analysis for Mainfreight
We are going to use a two stage model that takes into account two stages of growth. The first stage may have a high growth rate and the second stage is usually assumed to have a stable growth rate. To start off with we need to estimate the next 5 years of cash flows, where possible I use analysts estimates but when these aren’t available I have extrapolated the previous Free Cash Flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past 5 years, but capped to a reasonable level. The sum of these cash flows is then discounted to today’s value.
Step by step through the calculation
Note the numbers here are in millions apart from the per share values.
5-year cash flow forecast
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (NZD, Millions) | $86.00 | $89.00 | $86.00 | $91.10 | $96.50 |
Source | Analyst x2 | Analyst x2 | Analyst x1 | Extrapolated @ (5.93%) | Extrapolated @ (5.93%) |
Present Value Discounted @ 8.55% | $79.22 | $75.53 | $67.23 | $65.61 | $64.02 |
Present value of next 5 years cash flows: $352
After calculating the present value of cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the 1st stage. The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate of (2.8%).
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $97 × (1 + 2.8%) ÷ (8.6% – 2.8%)
Terminal value based on the Perpetuity Method where growth (g) = 2.8%: $1,712
Present value of terminal value: $1,136
So the total value is the sum of the next 5 years cash flows and the terminal value discounted to today, this is known as the Equity Value.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $352 + $1,136 = $1,488
In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number.
Value = Total value / Shares Outstanding ($1,487.51 / 100.70)
Value per share: $14.77
To finish off with if we compare the intrinsic value of 14.77 to the current share price of $22.05 we see Mainfreight (NZSE:MFT) is rather overvalued and not available at a discount at this time.
Important assumptions
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Mainfreight as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 8.6% and this is based on a Levered Beta of 0.8. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.
Conclusion
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Mainfreight in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NZSE every 6 hours. If you want to find the calculation for another other stock just search here.