Fair value estimate of Next Fifteen Communications Group plc (LON: NFC)
Today we’re going to review one way to estimate the intrinsic value of Next Fifteen Communications Group plc (LON: NFC) by taking expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Check out our latest analysis for Next Fifteen Communications Group
Step by step in the calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year free cash flow (FCF) forecast
|Leverage FCF (£, Million)||United Kingdom £ 44.0 million||United Kingdom £ 46.7 million||UK £ 50.1million||United Kingdom £ 48.6 million||United Kingdom £ 47.8 million||United Kingdom £ 47.4 million||£ 47.2 million||£ 47.2 million||United Kingdom £ 47.4 million||United Kingdom £ 47.6 million|
|Source of estimated growth rate||Analyst x3||Analyst x3||Analyst x2||East @ -2.8%||Is @ -1.69%||East @ -0.9%||East @ -0.36%||Is 0.03%||Is 0.29%||Is @ 0.48%|
|Present value (£, million) discounted at 5.7%||United Kingdom £ 41.6||United Kingdom £ 41.8||United Kingdom £ 42.4||United Kingdom £ 39.0||United Kingdom £ 36.3||United Kingdom £ 34.0||United Kingdom £ 32.1||£ 30.4||United Kingdom £ 28.8||United Kingdom £ 27.4|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = £ 353 million in the UK
We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.9%. We discount the terminal cash flows to their present value at a cost of equity of 5.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK £ 48m × (1 + 0.9%) ÷ (5.7% –0.9%) = UK £ 1.0b
Present value of terminal value (PVTV)= TV / (1 + r)ten= UK £ 1.0b ÷ (1 + 5.7%)ten= £ 580 million in the UK
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is £ 933million. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current UK £ 12.0 share price, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider Next Fifteen Communications 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 takes into account the debt. In this calculation, we used 5.7%, which is based on a leveraged beta of 0.897. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While important, calculating DCF is just one of the many factors you need to assess for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Next Fifteen Communications Group, we’ve put together three other things you should explore:
- Risks: As an example, we found 2 warning signs for Next Fifteen Communications Group that you need to consider before investing here.
- Future benefits: How does NFC’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every UK stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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