Calculating The Intrinsic Value Of Matrix Composites & Engineering Ltd (ASX:MCE)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Matrix Composites & Engineering fair value estimate is AU$0.34
• Matrix Composites & Engineering's AU$0.27 share price indicates it is trading at similar levels as its fair value estimate
• The average premium for Matrix Composites & Engineering's competitorsis currently 106%

How far off is Matrix Composites & Engineering Ltd (ASX:MCE) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Matrix Composites & Engineering

The Method

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 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (A$, Millions)	-AU$16.0m	AU$1.00m	AU$3.00m	AU$4.95m	AU$7.23m	AU$9.61m	AU$11.9m	AU$13.9m	AU$15.7m	AU$17.1m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 65.03%	Est @ 46.11%	Est @ 32.86%	Est @ 23.59%	Est @ 17.10%	Est @ 12.56%	Est @ 9.38%
Present Value (A$, Millions) Discounted @ 12%	-AU$14.2	AU$0.8	AU$2.1	AU$3.1	AU$4.0	AU$4.8	AU$5.2	AU$5.4	AU$5.4	AU$5.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$22m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = AU$17m× (1 + 2.0%) ÷ (12%– 2.0%) = AU$167m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$167m÷ ( 1 + 12%)¹⁰= AU$52m

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$73m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.3, the company appears about fair value at a 20% 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Matrix Composites & Engineering 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 12%, which is based on a levered beta of 1.765. 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.

SWOT Analysis for Matrix Composites & Engineering

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Matrix Composites & Engineering, we've put together three relevant items you should further research:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with Matrix Composites & Engineering (including 1 which is concerning) .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MCE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks 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.