Are Audinate Group Limited (ASX:AD8) Investors Paying Above The Intrinsic Value?

Key Insights

• The projected fair value for Audinate Group is AU$12.54 based on 2 Stage Free Cash Flow to Equity
• Current share price of AU$15.34 suggests Audinate Group is potentially 22% overvalued
• Our fair value estimate is 36% lower than Audinate Group's analyst price target of AU$19.59

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Audinate Group Limited (ASX:AD8) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Audinate Group

The Calculation

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (A$, Millions)	AU$10.3m	AU$21.4m	AU$30.0m	AU$38.6m	AU$46.6m	AU$53.7m	AU$59.8m	AU$65.0m	AU$69.3m	AU$73.1m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 40.09%	Est @ 28.74%	Est @ 20.80%	Est @ 15.24%	Est @ 11.34%	Est @ 8.62%	Est @ 6.71%	Est @ 5.38%
Present Value (A$, Millions) Discounted @ 7.2%	AU$9.6	AU$18.6	AU$24.3	AU$29.2	AU$32.9	AU$35.3	AU$36.7	AU$37.1	AU$37.0	AU$36.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$297m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$73m× (1 + 2.3%) ÷ (7.2%– 2.3%) = AU$1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$1.5b÷ ( 1 + 7.2%)¹⁰= AU$745m

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$1.0b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$15.3, the company appears slightly overvalued at the time of writing. 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

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Audinate Group 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 1.083. 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 Audinate Group

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Audinate Group, we've put together three fundamental elements you should further examine:

1. Risks: Every company has them, and we've spotted 1 warning sign for Audinate Group you should know about.
2. Future Earnings: How does AD8'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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com