How far off is Southern Cross Media Group Limited (ASX:SXL) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today’s value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.
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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Step by step through the calculation
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) estimate
|Levered FCF (A$, Millions)||AU$61.0m||AU$58.5m||AU$57.2m||AU$56.7m||AU$56.7m||AU$57.1m||AU$57.8m||AU$58.6m||AU$59.7m||AU$60.8m|
|Growth Rate Estimate Source||Analyst x1||Est @ -4.15%||Est @ -2.23%||Est @ -0.88%||Est @ 0.06%||Est @ 0.72%||Est @ 1.18%||Est @ 1.51%||Est @ 1.73%||Est @ 1.89%|
|Present Value (A$, Millions) Discounted @ 9.5%||AU$55.7||AU$48.7||AU$43.5||AU$39.3||AU$35.9||AU$33.0||AU$30.5||AU$28.3||AU$26.3||AU$24.4|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$365m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.3%. We discount the terminal cash flows to today’s value at a cost of equity of 9.5%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = AU$61m× (1 + 2.3%) ÷ (9.5%– 2.3%) = AU$854m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$854m÷ ( 1 + 9.5%)10= AU$343m
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$708m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$0.2, the company appears quite undervalued at a 39% 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.
We would 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 these result, have a go at the calculation yourself and play with the 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 Southern Cross Media 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 9.5%, which is based on a levered beta of 1.212. 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.
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. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. 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 Southern Cross Media Group, we’ve compiled three important items you should look at:
- Risks: To that end, you should learn about the 4 warning signs we’ve spotted with Southern Cross Media Group (including 2 which don’t sit too well with us) .
- Future Earnings: How does SXL’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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
When trading Southern Cross Media Group or any other investment, use the platform considered by many to be the Professional’s Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.