Key Insights

EBOS Group's estimated fair value is NZ$47.13 based on 2 Stage Free Cash Flow to Equity Current share price of NZ$37.24 suggests EBOS Group is potentially 21% undervalued Our fair value estimate is 22% higher than EBOS Group's analyst price target of AU$38.49

Today we will run through one way of estimating the intrinsic value of EBOS Group Limited (NZSE:EBO) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for EBOS Group

Is EBOS Group 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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (A$, Millions)  AU$272.7m AU$317.1m AU$346.6m AU$299.1m AU$325.2m AU$326.5m AU$330.3m AU$336.0m AU$343.0m AU$351.1m Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Analyst x1 Analyst x1 Est @ 0.39% Est @ 1.17% Est @ 1.72% Est @ 2.10% Est @ 2.37% Present Value (A$, Millions) Discounted @ 6.3%  AU$257 AU$281 AU$289 AU$234 AU$240 AU$226 AU$216 AU$206 AU$198 AU$191

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$2.3b

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. 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 (3.0%) 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 6.3%.

Story Continues

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$351m× (1 + 3.0%) ÷ (6.3%– 3.0%) = AU$11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$11b÷ ( 1 + 6.3%)10= AU$6.0b

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$8.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$37.2, the company appears a touch undervalued at a 21% 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.NZSE:EBO Discounted Cash Flow January 26th 2025

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 EBOS Group 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 6.3%, which is based on a levered beta of 0.800. 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 EBOS Group

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by earnings and cashflows.

Weakness

Earnings growth over the past year is below its 5-year average.

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

Opportunity

Annual earnings are forecast to grow for the next 3 years.

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

Threat

Dividends are not covered by cash flow.

Annual earnings are forecast to grow slower than the New Zealander market.

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. Can we work out why the company is trading at a discount to intrinsic value? For EBOS Group, we've compiled three fundamental elements you should explore:

Risks: As an example, we've found 1 warning sign for EBOS Group that you need to consider before investing here. Future Earnings: How does EBO'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 NZSE 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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