Calculating The Fair Value Of TI Fluid Systems plc (LON:TIFS)

Key Insights

• TI Fluid Systems' estimated fair value is UK£1.65 based on 2 Stage Free Cash Flow to Equity

• TI Fluid Systems' UK£1.35 share price indicates it is trading at similar levels as its fair value estimate

• The €1.42 analyst price target for TIFS is 14% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of TI Fluid Systems plc (LON:TIFS) as an investment opportunity 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for TI Fluid Systems

The Model

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (€, Millions)	€119.5m	€129.2m	€136.1m	€141.8m	€146.4m	€150.3m	€153.7m	€156.7m	€159.4m	€161.9m
Growth Rate Estimate Source	Analyst x5	Analyst x3	Est @ 5.39%	Est @ 4.15%	Est @ 3.27%	Est @ 2.66%	Est @ 2.24%	Est @ 1.94%	Est @ 1.73%	Est @ 1.58%
Present Value (€, Millions) Discounted @ 15%	€104	€97.4	€89.1	€80.6	€72.2	€64.4	€57.1	€50.6	€44.7	€39.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €699m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = €162m× (1 + 1.2%) ÷ (15%– 1.2%) = €1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €1.2b÷ ( 1 + 15%)¹⁰= €286m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €985m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.3, the company appears about fair value at a 18% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

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 TI Fluid Systems 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 15%, which is based on a levered beta of 2.000. 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 TI Fluid Systems

Strength

• No major strengths identified for TIFS.

Weakness

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Auto Components market.

Opportunity

• Expected to breakeven next year.

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

• Good value based on P/S ratio and estimated fair value.

Threat

• Debt is not well covered by operating cash flow.

• Paying a dividend but company is unprofitable.

Looking Ahead:

Whilst important, the DCF calculation 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For TI Fluid Systems, we've put together three additional factors you should assess:

1. Risks: You should be aware of the 1 warning sign for TI Fluid Systems we've uncovered before considering an investment in the company.

2. Future Earnings: How does TIFS'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.

3. 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. Simply Wall St updates its DCF calculation for every British 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.

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