Is Seeing Machines Limited (LON:SEE) Trading At A 43% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Seeing Machines fair value estimate is UK£0.10

• Current share price of UK£0.057 suggests Seeing Machines is potentially 43% undervalued

• Our fair value estimate is 32% lower than Seeing Machines' analyst price target of US$0.15

How far off is Seeing Machines Limited (LON:SEE) 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 today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Seeing Machines

The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	-US$28.4m	-US$21.4m	-US$1.73m	US$12.2m	US$22.4m	US$30.9m	US$39.3m	US$46.9m	US$53.5m	US$58.9m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 38.28%	Est @ 27.17%	Est @ 19.39%	Est @ 13.94%	Est @ 10.13%
Present Value ($, Millions) Discounted @ 7.9%	-US$26.3	-US$18.4	-US$1.4	US$9.0	US$15.3	US$19.5	US$23.0	US$25.5	US$26.9	US$27.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$101m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$59m× (1 + 1.2%) ÷ (7.9%– 1.2%) = US$889m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$889m÷ ( 1 + 7.9%)¹⁰= US$414m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$514m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£0.06, the company appears quite good value at a 43% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Seeing Machines 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 7.9%, which is based on a levered beta of 1.129. 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 Seeing Machines

Strength

• Debt is well covered by earnings.

Weakness

• No major weaknesses identified for SEE.

Opportunity

• Trading below our estimate of fair value by more than 20%.

• Significant insider buying over the past 3 months.

Threat

• Debt is not well covered by operating cash flow.

• Has less than 3 years of cash runway based on current free cash flow.

Moving On:

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. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value higher than the current share price? For Seeing Machines, we've put together three fundamental factors you should look at:

1. Financial Health: Does SEE 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 SEE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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 British stock every day, so if you want to find the intrinsic value of any other stock 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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here