Tracsis plc (LON:TRCS) Shares Could Be 40% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Tracsis is UK£6.22 based on 2 Stage Free Cash Flow to Equity
• Tracsis' UK£3.70 share price signals that it might be 40% undervalued
• Our fair value estimate is 11% lower than Tracsis' analyst price target of UK£7.01

Today we will run through one way of estimating the intrinsic value of Tracsis plc (LON:TRCS) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

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The Method

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. 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (£, Millions)	UK£7.77m	UK£8.86m	UK£10.1m	UK£10.9m	UK£11.7m	UK£12.3m	UK£12.9m	UK£13.4m	UK£13.8m	UK£14.2m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x2	Est @ 8.77%	Est @ 6.83%	Est @ 5.47%	Est @ 4.52%	Est @ 3.85%	Est @ 3.39%	Est @ 3.06%
Present Value (£, Millions) Discounted @ 8.1%	UK£7.2	UK£7.6	UK£8.0	UK£8.0	UK£7.9	UK£7.7	UK£7.5	UK£7.2	UK£6.8	UK£6.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£74m

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 (2.3%) 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 8.1%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£14m× (1 + 2.3%) ÷ (8.1%– 2.3%) = UK£250m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£250m÷ ( 1 + 8.1%)¹⁰= UK£115m

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£189m. 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£3.7, 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Tracsis 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 8.1%, which is based on a levered beta of 1.135. 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.

See our latest analysis for Tracsis

SWOT Analysis for Tracsis

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. 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 Tracsis, we've put together three fundamental aspects you should further research:

1. Risks: For example, we've discovered 2 warning signs for Tracsis (1 doesn't sit too well with us!) that you should be aware of before investing here.
2. Future Earnings: How does TRCS'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.

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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.