Estimating The Intrinsic Value Of MLG Oz Limited (ASX:MLG)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, MLG Oz fair value estimate is AU$0.76
• MLG Oz's AU$0.69 share price indicates it is trading at similar levels as its fair value estimate
• Peers of MLG Oz are currently trading on average at a 21% premium

Today we will run through one way of estimating the intrinsic value of MLG Oz Limited (ASX:MLG) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for MLG Oz

Is MLG Oz Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$10.8m	AU$8.60m	AU$11.0m	AU$9.67m	AU$8.92m	AU$8.50m	AU$8.27m	AU$8.17m	AU$8.16m	AU$8.21m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -12.07%	Est @ -7.77%	Est @ -4.76%	Est @ -2.65%	Est @ -1.18%	Est @ -0.15%	Est @ 0.57%
Present Value (A$, Millions) Discounted @ 9.0%	AU$9.9	AU$7.2	AU$8.5	AU$6.8	AU$5.8	AU$5.1	AU$4.5	AU$4.1	AU$3.7	AU$3.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$59m

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 9.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$8.2m× (1 + 2.3%) ÷ (9.0%– 2.3%) = AU$124m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$124m÷ ( 1 + 9.0%)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$111m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$0.7, the company appears about fair value at a 9.0% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 MLG Oz 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 9.0%, which is based on a levered beta of 1.473. 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 MLG Oz

Next Steps:

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. DCF models are not the be-all and end-all of investment valuation. 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. 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. For MLG Oz, we've compiled three important elements you should further research:

1. Risks: Be aware that MLG Oz is showing 2 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does MLG'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.