Ainsworth Game Technology Limited's (ASX:AGI) Intrinsic Value Is Potentially 49% Above Its Share Price

Key Insights

• The projected fair value for Ainsworth Game Technology is AU$1.70 based on 2 Stage Free Cash Flow to Equity
• Ainsworth Game Technology's AU$1.14 share price signals that it might be 33% undervalued
• Ainsworth Game Technology's peers seem to be trading at a lower discount to fair value based onthe industry average of 15%

Does the March share price for Ainsworth Game Technology Limited (ASX:AGI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Ainsworth Game Technology

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$43.7m	AU$38.1m	AU$35.0m	AU$33.2m	AU$32.2m	AU$31.8m	AU$31.7m	AU$31.8m	AU$32.1m	AU$32.6m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -8.17%	Est @ -5.07%	Est @ -2.90%	Est @ -1.38%	Est @ -0.32%	Est @ 0.42%	Est @ 0.94%	Est @ 1.31%
Present Value (A$, Millions) Discounted @ 7.2%	AU$40.8	AU$33.1	AU$28.4	AU$25.1	AU$22.8	AU$20.9	AU$19.5	AU$18.2	AU$17.2	AU$16.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$242m

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$33m× (1 + 2.2%) ÷ (7.2%– 2.2%) = AU$659m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$659m÷ ( 1 + 7.2%)¹⁰= AU$329m

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$571m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$1.1, the company appears quite undervalued at a 33% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Ainsworth Game Technology 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 7.2%, which is based on a levered beta of 1.097. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Ainsworth Game Technology, we've compiled three essential items you should consider:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Ainsworth Game Technology (including 1 which is concerning) .
2. Future Earnings: How does AGI'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.
3. 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.

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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.