Calculating The Fair Value Of Clover Corporation Limited (ASX:CLV)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Clover fair value estimate is AU$0.62

• Current share price of AU$0.58 suggests Clover is potentially trading close to its fair value

• Industry average discount to fair value of 46% suggests Clover's peers are currently trading at a higher discount

Does the March share price for Clover Corporation Limited (ASX:CLV) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Clover

The Calculation

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 begin with, we have to get estimates of 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$3.56m	AU$4.06m	AU$4.48m	AU$4.83m	AU$5.13m	AU$5.39m	AU$5.61m	AU$5.81m	AU$5.99m	AU$6.16m
Growth Rate Estimate Source	Est @ 19.00%	Est @ 13.95%	Est @ 10.41%	Est @ 7.94%	Est @ 6.20%	Est @ 4.99%	Est @ 4.14%	Est @ 3.55%	Est @ 3.13%	Est @ 2.84%
Present Value (A$, Millions) Discounted @ 6.9%	AU$3.3	AU$3.6	AU$3.7	AU$3.7	AU$3.7	AU$3.6	AU$3.5	AU$3.4	AU$3.3	AU$3.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$35m

We now need to calculate the Terminal Value, which accounts for all the 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 have used the 5-year average of the 10-year government bond yield (2.2%) 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$6.2m× (1 + 2.2%) ÷ (6.9%– 2.2%) = AU$134m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$134m÷ ( 1 + 6.9%)¹⁰= AU$69m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$104m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$0.6, the company appears about fair value at a 6.7% 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.

dcf

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 Clover 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 6.9%, which is based on a levered beta of 1.023. 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 Clover

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the Chemicals market.

Opportunity

• Annual earnings are forecast to grow faster than the Australian market.

• Current share price is below our estimate of fair value.

Threat

• Dividends are not covered by earnings and cashflows.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For Clover, we've compiled three pertinent factors you should look at:

1. Risks: Be aware that Clover is showing 2 warning signs in our investment analysis , you should know about...

2. Future Earnings: How does CLV'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 ASX every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.