CyanConnode Holdings plc (LON:CYAN) Shares Could Be 47% Below Their Intrinsic Value Estimate

Does the January share price for CyanConnode Holdings plc (LON:CYAN) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for CyanConnode Holdings

The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, 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£200.0k	UK£400.0k	UK£1.90m	UK£3.10m	UK£4.60m	UK£5.77m	UK£6.81m	UK£7.69m	UK£8.41m	UK£8.99m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 25.40%	Est @ 18.08%	Est @ 12.95%	Est @ 9.36%	Est @ 6.85%
Present Value (£, Millions) Discounted @ 9.3%	-UK£0.2	UK£0.3	UK£1.5	UK£2.2	UK£3.0	UK£3.4	UK£3.7	UK£3.8	UK£3.8	UK£3.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£25m

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 9.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£9.0m× (1 + 1.0%) ÷ (9.3%– 1.0%) = UK£110m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£110m÷ ( 1 + 9.3%)¹⁰= UK£45m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£70m. 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 47% 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.

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 CyanConnode 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 9.3%, which is based on a levered beta of 1.208. 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 CyanConnode Holdings

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For CyanConnode Holdings, there are three relevant aspects you should further examine:

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