- Using the 2 Stage Free Cash Flow to Equity, Wilmington fair value estimate is UK£6.84
- Wilmington is estimated to be 49% undervalued based on current share price of UK£3.52
Today we will run through one way of estimating the intrinsic value of Wilmington plc (LON:WIL) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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.
Is Wilmington Fairly Valued?
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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF (£, Millions)||UK£26.7m||UK£28.9m||UK£31.4m||UK£32.5m||UK£33.4m||UK£34.2m||UK£35.0m||UK£35.6m||UK£36.2m||UK£36.8m|
|Growth Rate Estimate Source||Analyst x1||Analyst x1||Analyst x1||Est @ 3.51%||Est @ 2.87%||Est @ 2.42%||Est @ 2.11%||Est @ 1.89%||Est @ 1.74%||Est @ 1.63%|
|Present Value (£, Millions) Discounted @ 6.6%||UK£25.0||UK£25.4||UK£25.9||UK£25.1||UK£24.2||UK£23.3||UK£22.3||UK£21.3||UK£20.3||UK£19.4|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£232m
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 (1.4%) 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 6.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£37m× (1 + 1.4%) ÷ (6.6%– 1.4%) = UK£711m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£711m÷ ( 1 + 6.6%)10= UK£374m
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£606m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£3.5, the company appears quite undervalued at a 49% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Wilmington 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 6.6%, which is based on a levered beta of 0.889. 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 Wilmington
- Currently debt free.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Professional Services market.
- Annual revenue is forecast to grow faster than the British market.
- Trading below our estimate of fair value by more than 20%.
- No apparent threats visible for WIL.
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Wilmington, we've compiled three additional items you should assess:
- Risks: For example, we've discovered 2 warning signs for Wilmington that you should be aware of before investing here.
- Future Earnings: How does WIL'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.
- 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 LSE 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.