Estimating The Intrinsic Value Of CT Automotive Group plc (LON:CTA)

Key Insights

• CT Automotive Group's estimated fair value is UK£0.50 based on 2 Stage Free Cash Flow to Equity
• CT Automotive Group's UK£0.40 share price indicates it is trading at similar levels as its fair value estimate
• CT Automotive Group's peers seem to be trading at a higher discount to fair value based onthe industry average of 33%

Today we will run through one way of estimating the intrinsic value of CT Automotive Group plc (LON:CTA) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 CT Automotive Group

Crunching The Numbers

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

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$11.1m	US$6.96m	US$4.95m	US$3.97m	US$3.43m	US$3.11m	US$2.92m	US$2.81m	US$2.74m	US$2.71m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -28.89%	Est @ -19.87%	Est @ -13.57%	Est @ -9.15%	Est @ -6.06%	Est @ -3.90%	Est @ -2.38%	Est @ -1.32%
Present Value ($, Millions) Discounted @ 15%	US$9.6	US$5.3	US$3.2	US$2.3	US$1.7	US$1.3	US$1.1	US$0.9	US$0.8	US$0.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$27m

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. 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 (1.2%) 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 15%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$2.7m× (1 + 1.2%) ÷ (15%– 1.2%) = US$20m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$20m÷ ( 1 + 15%)¹⁰= US$4.8m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$32m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.4, the company appears about fair value at a 20% 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.

The 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 CT Automotive 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 15%, which is based on a levered beta of 2.000. 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 CT Automotive Group

Next Steps:

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. 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 CT Automotive Group, we've put together three essential elements you should further research:

1. Risks: Be aware that CT Automotive Group is showing 4 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
2. Future Earnings: How does CTA'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 AIM every day. If you want to find the calculation for other stocks 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.