Estimating The Intrinsic Value Of Animalcare Group plc (LON:ANCR)

Key Insights

• Animalcare Group's estimated fair value is UK£2.1 based on 2 Stage Free Cash Flow to Equity
• Current share price of UK£2.0 suggests Animalcare Group is trading close to its fair value
• Industry average of 34% suggests Animalcare Group's peers are currently trading at a higher discount

In this article we are going to estimate the intrinsic value of Animalcare Group plc (LON:ANCR) by taking the expected future cash flows and discounting them 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.

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

Check out our latest analysis for Animalcare Group

Crunching The Numbers

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	UK£8.60m	UK£8.02m	UK£7.66m	UK£7.44m	UK£7.32m	UK£7.25m	UK£7.23m	UK£7.24m	UK£7.26m	UK£7.30m
Growth Rate Estimate Source	Analyst x1	Est @ -6.79%	Est @ -4.45%	Est @ -2.82%	Est @ -1.68%	Est @ -0.88%	Est @ -0.32%	Est @ 0.08%	Est @ 0.35%	Est @ 0.54%
Present Value (£, Millions) Discounted @ 6.5%	UK£8.1	UK£7.1	UK£6.3	UK£5.8	UK£5.3	UK£5.0	UK£4.7	UK£4.4	UK£4.1	UK£3.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£55m

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 (1.0%) 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 6.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£7.3m× (1 + 1.0%) ÷ (6.5%– 1.0%) = UK£135m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£135m÷ ( 1 + 6.5%)¹⁰= UK£72m

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£127m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.0, the company appears about fair value at a 7.4% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now 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 Animalcare Group 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 6.5%, which is based on a levered beta of 0.800. 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 Animalcare Group

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. For Animalcare Group, there are three additional elements you should look at:

1. Risks: As an example, we've found 2 warning signs for Animalcare Group (1 is significant!) that you need to consider before investing here.
2. Future Earnings: How does ANCR'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. 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.

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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.