Estimating The Fair Value Of EVZ Limited (ASX:EVZ)

Key Insights

• The projected fair value for EVZ is AU$0.21 based on 2 Stage Free Cash Flow to Equity
• EVZ's AU$0.18 share price indicates it is trading at similar levels as its fair value estimate
• Industry average discount to fair value of 39% suggests EVZ's peers are currently trading at a higher discount

In this article we are going to estimate the intrinsic value of EVZ Limited (ASX:EVZ) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. 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.

View our latest analysis for EVZ

The 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. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$2.00m	AU$1.75m	AU$1.61m	AU$1.53m	AU$1.49m	AU$1.47m	AU$1.46m	AU$1.47m	AU$1.48m	AU$1.50m
Growth Rate Estimate Source	Est @ -18.46%	Est @ -12.30%	Est @ -7.98%	Est @ -4.97%	Est @ -2.85%	Est @ -1.37%	Est @ -0.34%	Est @ 0.39%	Est @ 0.90%	Est @ 1.25%
Present Value (A$, Millions) Discounted @ 7.3%	AU$1.9	AU$1.5	AU$1.3	AU$1.2	AU$1.0	AU$1.0	AU$0.9	AU$0.8	AU$0.8	AU$0.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$11m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$1.5m× (1 + 2.1%) ÷ (7.3%– 2.1%) = AU$29m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$29m÷ ( 1 + 7.3%)¹⁰= AU$15m

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$26m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.2, the company appears about fair value at a 15% 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.

The Assumptions

Now 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 EVZ 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 7.3%, which is based on a levered beta of 1.041. 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.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For EVZ, we've put together three essential items you should assess:

1. Risks: You should be aware of the 2 warning signs for EVZ (1 doesn't sit too well with us!) we've uncovered before considering an investment in the company.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.