Calculating The Intrinsic Value Of TheWorks.co.uk plc (LON:WRKS)

Key Insights

• The projected fair value for TheWorks.co.uk is UK£0.22 based on 2 Stage Free Cash Flow to Equity

• With UK£0.22 share price, TheWorks.co.uk appears to be trading close to its estimated fair value

• TheWorks.co.uk's peers seem to be trading at a higher discount to fair value based onthe industry average of 7.8%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of TheWorks.co.uk plc (LON:WRKS) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for TheWorks.co.uk

Crunching The Numbers

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	-UK£5.47m	UK£2.45m	UK£4.60m	UK£3.38m	UK£2.77m	UK£2.43m	UK£2.23m	UK£2.12m	UK£2.05m	UK£2.02m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x1	Est @ -26.58%	Est @ -18.12%	Est @ -12.19%	Est @ -8.04%	Est @ -5.14%	Est @ -3.10%	Est @ -1.68%
Present Value (£, Millions) Discounted @ 13%	-UK£4.9	UK£1.9	UK£3.2	UK£2.1	UK£1.5	UK£1.2	UK£1.0	UK£0.8	UK£0.7	UK£0.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£8.2m

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£2.0m× (1 + 1.6%) ÷ (13%– 1.6%) = UK£19m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£19m÷ ( 1 + 13%)¹⁰= UK£5.7m

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£14m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.2, the company appears about fair value at a 0.3% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 TheWorks.co.uk 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 13%, which is based on a levered beta of 2.000. 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 TheWorks.co.uk

Strength

• Debt is well covered by earnings and cashflows.

Weakness

• No major weaknesses identified for WRKS.

Opportunity

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Good value based on P/S ratio and estimated fair value.

Threat

• Total liabilities exceed total assets, which raises the risk of financial distress.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For TheWorks.co.uk, we've compiled three relevant elements you should assess:

1. Risks: You should be aware of the 2 warning signs for TheWorks.co.uk (1 is a bit unpleasant!) we've uncovered before considering an investment in the company.

2. Future Earnings: How does WRKS'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 LSE 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.