A Look At The Intrinsic Value Of Michelmersh Brick Holdings plc (LON:MBH)

In this article we are going to estimate the intrinsic value of Michelmersh Brick Holdings plc (LON:MBH) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Michelmersh Brick Holdings

The calculation

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (£, Millions)	UK£8.18m	UK£7.47m	UK£7.04m	UK£6.78m	UK£6.62m	UK£6.53m	UK£6.49m	UK£6.48m	UK£6.50m	UK£6.53m
Growth Rate Estimate Source	Est @ -12.81%	Est @ -8.67%	Est @ -5.77%	Est @ -3.74%	Est @ -2.32%	Est @ -1.32%	Est @ -0.63%	Est @ -0.14%	Est @ 0.2%	Est @ 0.44%
Present Value (£, Millions) Discounted @ 6.2%	UK£7.7	UK£6.6	UK£5.9	UK£5.3	UK£4.9	UK£4.6	UK£4.3	UK£4.0	UK£3.8	UK£3.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£50m

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 1.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = UK£6.5m× (1 + 1.0%) ÷ (6.2%– 1.0%) = UK£128m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£128m÷ ( 1 + 6.2%)¹⁰= UK£70m

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£120m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£1.4, 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.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Michelmersh Brick Holdings 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 6.2%, which is based on a levered beta of 0.866. 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:

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. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Michelmersh Brick Holdings, we've put together three relevant elements you should further research:

1. Risks: Be aware that Michelmersh Brick Holdings is showing 2 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does MBH'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. 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. 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.
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