Key Insights

Elixirr International's estimated fair value is UK£8.47 based on 2 Stage Free Cash Flow to Equity Current share price of UK£5.10 suggests Elixirr International is potentially 40% undervalued

Today we will run through one way of estimating the intrinsic value of Elixirr International plc (LON:ELIX) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Elixirr International

The Method

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.

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) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (£, Millions)  UK£17.0m UK£19.3m UK£20.9m UK£22.2m UK£23.3m UK£24.1m UK£24.8m UK£25.4m UK£25.9m UK£26.4m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 8.51% Est @ 6.30% Est @ 4.76% Est @ 3.67% Est @ 2.92% Est @ 2.39% Est @ 2.02% Est @ 1.76% Present Value (£, Millions) Discounted @ 7.0%  UK£15.8 UK£16.8 UK£17.1 UK£16.9 UK£16.6 UK£16.1 UK£15.5 UK£14.8 UK£14.1 UK£13.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£157m



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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£26m× (1 + 1.2%) ÷ (7.0%– 1.2%) = UK£457m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£457m÷ ( 1 + 7.0%)10= UK£232m

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£390m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£5.1, the company appears quite good value at a 40% 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

The 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 Elixirr International 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 7.0%, which is based on a levered beta of 0.838. 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 Elixirr International

Strength

Earnings growth over the past year exceeded the industry.

Currently debt free.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Professional Services market.

Opportunity

Annual earnings are forecast to grow faster than the British market.

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

Threat

No apparent threats visible for ELIX.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Elixirr International, there are three additional elements you should further research:

Risks: Consider for instance, the ever-present spectre of investment risk.  We've identified 1 warning sign  with Elixirr International , and understanding this should be part of your investment process. Future Earnings: How does ELIX'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. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM 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.

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