Key Insights

Orica's estimated fair value is AU$34.21 based on 2 Stage Free Cash Flow to Equity Current share price of AU$21.27 suggests Orica is potentially 38% undervalued Our fair value estimate is 59% higher than Orica's analyst price target of AU$21.56

How far off is Orica Limited (ASX:ORI) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

Is Orica Fairly Valued?

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, 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

2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Levered FCF (A$, Millions)  AU$772.3m AU$852.8m AU$768.0m AU$814.0m AU$824.1m AU$838.5m AU$856.2m AU$876.4m AU$898.6m AU$922.6m Growth Rate Estimate Source Analyst x5 Analyst x4 Analyst x1 Analyst x1 Est @ 1.24% Est @ 1.75% Est @ 2.11% Est @ 2.36% Est @ 2.54% Est @ 2.66% Present Value (A$, Millions) Discounted @ 7.4%  AU$719 AU$740 AU$621 AU$613 AU$578 AU$548 AU$521 AU$497 AU$475 AU$454

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$5.8b

Story Continues

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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = AU$923m× (1 + 2.9%) ÷ (7.4%– 2.9%) = AU$22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$22b÷ ( 1 + 7.4%)10= AU$11b

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$16b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$21.3, the company appears quite undervalued at a 38% 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.ASX:ORI Discounted Cash Flow July 23rd 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Orica 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 7.4%, which is based on a levered beta of 1.017. 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 Orica

SWOT Analysis for Orica

Strength

Debt is well covered by earnings and cashflows.

Weakness

Earnings declined over the past year.

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

Opportunity

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

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

Threat

Dividends are not covered by earnings.

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

Next Steps:

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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Orica, we've put together three relevant items you should further examine:

Risks: As an example, we've found 2 warning signs for Orica that you need to consider before investing here. Future Earnings: How does ORI'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. Simply Wall St updates its DCF calculation for every Australian 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.

View Comments