Key Insights

Using the 2 Stage Free Cash Flow to Equity, Gates Industrial fair value estimate is US$44.96 Gates Industrial is estimated to be 50% undervalued based on current share price of US$22.60 Analyst price target for GTES is US$23.80 which is 47% below our fair value estimate

Does the May share price for Gates Industrial Corporation plc (NYSE:GTES) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Crunching The Numbers

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. To start off with, we need to estimate 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.

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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  US$343.0m US$456.9m US$546.0m US$613.0m US$670.7m US$720.5m US$763.8m US$802.3m US$837.2m US$869.6m Growth Rate Estimate Source Analyst x3 Analyst x2 Analyst x1 Est @ 12.27% Est @ 9.42% Est @ 7.42% Est @ 6.02% Est @ 5.04% Est @ 4.35% Est @ 3.87% Present Value ($, Millions) Discounted @ 8.2%  US$317 US$390 US$431 US$447 US$452 US$448 US$439 US$426 US$411 US$395

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.2b

Story Continues

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.8%) 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)= FCF2034 × (1 + g) ÷ (r – g) = US$870m× (1 + 2.8%) ÷ (8.2%– 2.8%) = US$16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$16b÷ ( 1 + 8.2%)10= US$7.4b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$12b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$22.6, the company appears quite good value at a 50% 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.NYSE:GTES Discounted Cash Flow May 14th 2025

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Gates Industrial 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 1.264. 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.

See our latest analysis for Gates Industrial

SWOT Analysis for Gates Industrial

Strength

Debt is well covered by earnings.

Weakness

Earnings declined over the past year.

Opportunity

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

Good value based on P/E ratio and estimated fair value.

Significant insider buying over the past 3 months.

Threat

Debt is not well covered by operating cash flow.

Annual revenue is forecast to grow slower than the American market.

Moving On:

Whilst important, the DCF calculation 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. 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 sitting below the intrinsic value? For Gates Industrial, we've put together three additional items you should further examine:

Risks: Every company has them, and we've spotted  1 warning sign for Gates Industrial  you should know about. Future Earnings: How does GTES'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 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 NYSE 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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