Is Envirosuite Limited (ASX:EVS) Trading At A 48% Discount?

Key Insights

• The projected fair value for Envirosuite is AU$0.13 based on 2 Stage Free Cash Flow to Equity
• Envirosuite is estimated to be 48% undervalued based on current share price of AU$0.068
• Analyst price target for EVS is AU$0.051 which is 61% below our fair value estimate

In this article we are going to estimate the intrinsic value of Envirosuite Limited (ASX:EVS) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Envirosuite

What's The Estimated Valuation?

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. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (A$, Millions)	-AU$2.60m	AU$100.0k	AU$1.60m	AU$2.79m	AU$4.26m	AU$5.87m	AU$7.46m	AU$8.93m	AU$10.2m	AU$11.3m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 74.38%	Est @ 52.79%	Est @ 37.67%	Est @ 27.09%	Est @ 19.69%	Est @ 14.51%	Est @ 10.88%
Present Value (A$, Millions) Discounted @ 6.8%	-AU$2.4	AU$0.09	AU$1.3	AU$2.1	AU$3.1	AU$4.0	AU$4.7	AU$5.3	AU$5.7	AU$5.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$30m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$11m× (1 + 2.4%) ÷ (6.8%– 2.4%) = AU$265m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$265m÷ ( 1 + 6.8%)¹⁰= AU$138m

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$167m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.07, the company appears quite good value at a 48% 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 Envirosuite 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 6.8%, which is based on a levered beta of 1.062. 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 Envirosuite

Looking Ahead:

Whilst important, the DCF calculation 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 Envirosuite, there are three additional aspects you should consider:

1. Risks: Every company has them, and we've spotted 2 warning signs for Envirosuite you should know about.
2. Future Earnings: How does EVS'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.