Calculation of the intrinsic value of Carbon Revolution Limited (ASX: CBR)
Today we’re going to review one way to estimate the intrinsic value of Carbon Revolution Limited (ASX: CBR) by estimating the company’s future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
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We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
|Leverage FCF (A $, Millions)||– 68.5 million Australian dollars||– 22.9 million Australian dollars||-600.0k AU $||AU $ 17.3 million||AU $ 21.5 million||24.6 million Australian dollars||AU $ 27.3 million||AU $ 29.5 million||AU $ 31.3 million||32.9 million Australian dollars|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Est @ 14.53%||Est @ 10.74%||Est @ 8.1%||Est @ 6.24%||Est @ 4.95%|
|Present value (A $, Millions) discounted at 8.7%||-At $ 63.0||-A $ 19.4||-0.5 AU $||AU $ 12.4||A $ 14.2||A $ 15.0||AU $ 15.3||A $ 15.2||AU $ 14.8||AU $ 14.3|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = AU $ 18 million
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. 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 used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 8.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU $ 33 million × (1 + 1.9%) ÷ (8.7% – 1.9%) = AU $ 497 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= AU $ 497 million ÷ (1 + 8.7%)ten= AU $ 217 million
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is AU $ 235 million. In the last step, we divide the equity value by the number of shares outstanding. From the current stock price of AU $ 1.1, the company appears to be roughly at fair value with a 2.3% discount from where the stock price is currently trading. . Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Carbon Revolution 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 takes debt into account. In this calculation, we used 8.7%, which is based on a leveraged beta of 1.427. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Carbon Revolution, we’ve put together three other factors that you should take a closer look at:
- Risks: For example, we have identified 3 warning signs of the Carbon Revolution that you need to be aware of.
- Future benefits: How does CBR’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each ASX share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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