Stock Analysis

An Intrinsic Calculation For Wentworth Resources plc (LON:WEN) Suggests It's 44% Undervalued

  •  Updated
AIM:WEN
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Today we will run through one way of estimating the intrinsic value of Wentworth Resources plc (LON:WEN) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

See our latest analysis for Wentworth Resources

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) -US$400.0k US$21.0m US$15.0m US$9.00m US$6.13m US$4.77m US$4.05m US$3.63m US$3.38m US$3.22m
Growth Rate Estimate Source Analyst x2 Analyst x1 Analyst x1 Analyst x1 Est @ -31.94% Est @ -22.08% Est @ -15.18% Est @ -10.34% Est @ -6.96% Est @ -4.59%
Present Value ($, Millions) Discounted @ 6.0% -US$0.4 US$18.7 US$12.6 US$7.1 US$4.6 US$3.4 US$2.7 US$2.3 US$2.0 US$1.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$54m

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 (0.9%) 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 6.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.2m× (1 + 0.9%) ÷ (6.0%– 0.9%) = US$64m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$64m÷ ( 1 + 6.0%)10= US$36m

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$90m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.2, the company appears quite undervalued at a 44% discount to where the stock price trades currently. 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.

dcf
AIM:WEN Discounted Cash Flow September 2nd 2022

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. 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 Wentworth Resources 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 6.0%, which is based on a levered beta of 1.199. 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.

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. 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. Why is the intrinsic value higher than the current share price? For Wentworth Resources, we've put together three essential elements you should explore:

  1. Risks: We feel that you should assess the 2 warning signs for Wentworth Resources we've flagged before making an investment in the company.
  2. Future Earnings: How does WEN'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 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. 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.

Valuation is complex, but we're helping make it simple.

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About AIM:WEN

Wentworth Resources

Wentworth Resources plc engages in the exploration, development, and production of natural gas and other hydrocarbons.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation2
Future Growth0
Past Performance4
Financial Health6
Dividends3

Read more about these checks in the individual report sections or in our analysis model.

Flawless balance sheet with proven track record.