Stock Analysis

Is There An Opportunity With Imdex Limited's (ASX:IMD) 36% Undervaluation?

ASX:IMD
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Imdex fair value estimate is AU$3.48
  • Imdex is estimated to be 36% undervalued based on current share price of AU$2.22
  • The AU$2.18 analyst price target for IMD is 37% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Imdex Limited (ASX:IMD) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for Imdex

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.

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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (A$, Millions) AU$73.4m AU$72.6m AU$84.5m AU$88.2m AU$91.4m AU$94.5m AU$97.4m AU$100.1m AU$102.9m AU$105.6m
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Est @ 4.28% Est @ 3.72% Est @ 3.33% Est @ 3.05% Est @ 2.86% Est @ 2.72% Est @ 2.63%
Present Value (A$, Millions) Discounted @ 7.1% AU$68.5 AU$63.3 AU$68.8 AU$67.0 AU$64.9 AU$62.6 AU$60.2 AU$57.8 AU$55.5 AU$53.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$622m

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$106m× (1 + 2.4%) ÷ (7.1%– 2.4%) = AU$2.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$2.3b÷ ( 1 + 7.1%)10= AU$1.2b

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$1.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$2.2, the company appears quite good value at a 36% 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.

dcf
ASX:IMD Discounted Cash Flow August 28th 2024

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 Imdex 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 7.1%, which is based on a levered beta of 1.140. 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 Imdex

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.
Opportunity
  • Annual earnings are forecast to grow faster than the Australian market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Annual revenue is forecast to grow slower than the Australian market.

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Imdex, we've compiled three essential aspects you should further research:

  1. Financial Health: Does IMD have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does IMD'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. 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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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.