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Estimating The Fair Value Of Imdex Limited (ASX:IMD)

How far off is Imdex Limited (ASX:IMD) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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

View our latest analysis for Imdex

The calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

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A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF (A$, Millions)

AU$21.2m

AU$28.0m

AU$29.2m

AU$30.3m

AU$31.3m

AU$32.3m

AU$33.1m

AU$34.0m

AU$34.9m

AU$35.7m

Growth Rate Estimate Source

Analyst x4

Analyst x3

Est @ 4.37%

Est @ 3.74%

Est @ 3.3%

Est @ 2.99%

Est @ 2.77%

Est @ 2.62%

Est @ 2.51%

Est @ 2.43%

Present Value (A$, Millions) Discounted @ 8.2%

AU$19.6

AU$23.9

AU$23.1

AU$22.1

AU$21.1

AU$20.1

AU$19.1

AU$18.1

AU$17.2

AU$16.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$200m

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 8.2%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = AU$36m× (1 + 2.3%) ÷ (8.2%– 2.3%) = AU$616m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$616m÷ ( 1 + 8.2%)10= AU$280m

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$480m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.1, the company appears about fair value at a 9.9% 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.

ASX:IMD Discounted Cash Flow July 8th 2020
ASX:IMD Discounted Cash Flow July 8th 2020

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 Imdex 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 8.2%, which is based on a levered beta of 0.987. 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.

Moving On:

Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Imdex, there are three additional aspects you should further examine:

  1. Risks: We feel that you should assess the 3 warning signs for Imdex we've flagged before making an investment in the company.

  2. Future Earnings: How does IMD'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. Simply Wall St updates its DCF calculation for every AU stock every day, so if you want to find the intrinsic value of any other stock just search here.

This article by Simply Wall St is general in nature. 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.

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