Is There An Opportunity With Qube Holdings Limited's (ASX:QUB) 28% Undervaluation?

Key Insights

• The projected fair value for Qube Holdings is AU$5.51 based on 2 Stage Free Cash Flow to Equity
• Qube Holdings' AU$3.95 share price signals that it might be 28% undervalued
• Our fair value estimate is 29% higher than Qube Holdings' analyst price target of AU$4.26

In this article we are going to estimate the intrinsic value of Qube Holdings Limited (ASX:QUB) by estimating the company's future cash flows and discounting them to their present value. This will be done using 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Our free stock report includes 1 warning sign investors should be aware of before investing in Qube Holdings. Read for free now.

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (A$, Millions)	-AU$155.8m	AU$222.5m	AU$343.4m	AU$440.9m	AU$532.0m	AU$613.4m	AU$684.2m	AU$745.0m	AU$797.5m	AU$843.4m
Growth Rate Estimate Source	Analyst x5	Analyst x4	Analyst x3	Est @ 28.37%	Est @ 20.68%	Est @ 15.30%	Est @ 11.53%	Est @ 8.89%	Est @ 7.05%	Est @ 5.76%
Present Value (A$, Millions) Discounted @ 8.4%	-AU$144	AU$189	AU$270	AU$319	AU$355	AU$378	AU$389	AU$391	AU$386	AU$376

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$2.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.7%) 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = AU$843m× (1 + 2.7%) ÷ (8.4%– 2.7%) = AU$15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$15b÷ ( 1 + 8.4%)¹⁰= AU$6.8b

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$9.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$4.0, the company appears a touch undervalued at a 28% 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

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 Qube Holdings 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 8.4%, which is based on a levered beta of 1.308. 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.

View our latest analysis for Qube Holdings

SWOT Analysis for Qube Holdings

Next Steps:

Whilst important, the DCF calculation 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. Why is the intrinsic value higher than the current share price? For Qube Holdings, we've put together three pertinent factors you should further examine:

1. Risks: For example, we've discovered 1 warning sign for Qube Holdings that you should be aware of before investing here.
2. Future Earnings: How does QUB'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.

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.