A Look At The Fair Value Of Flowtech Fluidpower plc (LON:FLO)

By
Simply Wall St
Published
July 19, 2021
AIM:FLO
Source: Shutterstock

In this article we are going to estimate the intrinsic value of Flowtech Fluidpower plc (LON:FLO) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Flowtech Fluidpower

What's the estimated valuation?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (£, Millions) UK£5.47m UK£5.00m UK£4.73m UK£4.56m UK£4.46m UK£4.40m UK£4.37m UK£4.37m UK£4.37m UK£4.39m
Growth Rate Estimate Source Analyst x3 Analyst x2 Est @ -5.47% Est @ -3.55% Est @ -2.21% Est @ -1.27% Est @ -0.61% Est @ -0.15% Est @ 0.17% Est @ 0.39%
Present Value (£, Millions) Discounted @ 7.9% UK£5.1 UK£4.3 UK£3.8 UK£3.4 UK£3.0 UK£2.8 UK£2.6 UK£2.4 UK£2.2 UK£2.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£31m

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 0.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK£4.4m× (1 + 0.9%) ÷ (7.9%– 0.9%) = UK£64m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£64m÷ ( 1 + 7.9%)10= UK£30m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£61m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£1.2, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
AIM:FLO Discounted Cash Flow July 20th 2021

The assumptions

Now 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 Flowtech Fluidpower 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 7.9%, which is based on a levered beta of 1.314. 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.

Moving On:

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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Flowtech Fluidpower, there are three essential aspects you should look at:

  1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Flowtech Fluidpower .
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FLO's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just search here.

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