Key Insights

The projected fair value for Frontier Digital Ventures is AU$0.40 based on 2 Stage Free Cash Flow to Equity Frontier Digital Ventures' AU$0.50 share price signals that it might be 27% overvalued The AU$0.83 analyst price target for FDV is 111% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Frontier Digital Ventures Limited (ASX:FDV) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 Frontier Digital Ventures

Is Frontier Digital Ventures Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:



10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (A$, Millions)  -AU$600.0k AU$1.30m AU$4.00m AU$6.65m AU$9.77m AU$13.0m AU$16.2m AU$19.0m AU$21.4m AU$23.4m Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ 66.23% Est @ 46.94% Est @ 33.44% Est @ 23.99% Est @ 17.37% Est @ 12.74% Est @ 9.50% Present Value (A$, Millions) Discounted @ 10%  -AU$0.5 AU$1.1 AU$3.0 AU$4.5 AU$5.9 AU$7.2 AU$8.1 AU$8.6 AU$8.8 AU$8.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$55m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$23m× (1 + 1.9%) ÷ (10%– 1.9%) = AU$281m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$281m÷ ( 1 + 10%)10= AU$104m

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 AU$159m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.5, the company appears slightly overvalued at the time of writing. 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

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 Frontier Digital Ventures 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 10%, which is based on a levered beta of 1.062. 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 Frontier Digital Ventures

Strength

Debt is well covered by earnings.

Weakness

Expensive based on P/S ratio and estimated fair value.

Shareholders have been diluted in the past year.

Opportunity

Forecast to reduce losses next year.

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

Threat

Debt is not well covered by operating cash flow.

Next Steps:

Although the valuation of a company is important, it 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?" 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. What is the reason for the share price exceeding the intrinsic value? For Frontier Digital Ventures, we've compiled three essential factors you should look at:

Risks: For instance, we've identified  1 warning sign for Frontier Digital Ventures that you should be aware of. Future Earnings: How does FDV'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 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.

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