Is There An Opportunity With Mainfreight Limited's (NZSE:MFT) 27% Undervaluation?

Published
June 13, 2022
NZSE:MFT
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In this article we are going to estimate the intrinsic value of Mainfreight Limited (NZSE:MFT) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Mainfreight

What's the estimated valuation?

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. 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.

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) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (NZ$, Millions) NZ$340.1m NZ$378.7m NZ$411.0m NZ$438.2m NZ$461.1m NZ$480.8m NZ$498.1m NZ$513.8m NZ$528.2m NZ$541.8m
Growth Rate Estimate Source Est @ 15.33% Est @ 11.35% Est @ 8.55% Est @ 6.6% Est @ 5.23% Est @ 4.27% Est @ 3.6% Est @ 3.13% Est @ 2.81% Est @ 2.58%
Present Value (NZ$, Millions) Discounted @ 6.3% NZ$320 NZ$335 NZ$342 NZ$343 NZ$339 NZ$333 NZ$324 NZ$315 NZ$304 NZ$294

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$3.2b

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. 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = NZ$542m× (1 + 2.0%) ÷ (6.3%– 2.0%) = NZ$13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$13b÷ ( 1 + 6.3%)10= NZ$7.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$10b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$74.6, the company appears a touch undervalued at a 27% 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.

dcf
NZSE:MFT Discounted Cash Flow June 13th 2022

Important assumptions

We would point out that 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 Mainfreight 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 6.3%, which is based on a levered beta of 1.009. 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.

Looking Ahead:

Although the valuation of a company is important, it 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Mainfreight, there are three further factors you should look at:

  1. Financial Health: Does MFT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MFT's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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 New Zealander stock every day, so if you want to find the intrinsic value of any other stock just search here.

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