Is There An Opportunity With Anglo Asian Mining PLC's (LON:AAZ) 40% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Anglo Asian Mining fair value estimate is UK£1.20
• Current share price of UK£0.72 suggests Anglo Asian Mining is potentially 40% undervalued
• When compared to theindustry average discount to fair value of 33%, Anglo Asian Mining's competitors seem to be trading at a lesser discount

Today we will run through one way of estimating the intrinsic value of Anglo Asian Mining PLC (LON:AAZ) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for Anglo Asian Mining

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. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$11.1m	US$21.5m	US$18.3m	US$17.8m	US$17.6m	US$17.5m	US$17.6m	US$17.7m	US$17.8m	US$18.0m
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Analyst x1	Est @ -1.20%	Est @ -0.39%	Est @ 0.19%	Est @ 0.59%	Est @ 0.87%	Est @ 1.06%
Present Value ($, Millions) Discounted @ 11%	US$10.0	US$17.5	US$13.4	US$11.7	US$10.5	US$9.4	US$8.5	US$7.7	US$7.0	US$6.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$102m

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 (1.5%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$18m× (1 + 1.5%) ÷ (11%– 1.5%) = US$193m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$193m÷ ( 1 + 11%)¹⁰= US$68m

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$170m. 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£0.7, the company appears quite undervalued at a 40% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Anglo Asian Mining 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 11%, which is based on a levered beta of 1.074. 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 Anglo Asian Mining

Next Steps:

Whilst important, the DCF calculation 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Anglo Asian Mining, there are three pertinent items you should explore:

1. Risks: For example, we've discovered 3 warning signs for Anglo Asian Mining (1 is potentially serious!) that you should be aware of before investing here.
2. Future Earnings: How does AAZ'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 British stock every day, so if you want to find the intrinsic value of any other stock 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.