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Calculating The Fair Value Of Tracsis plc (LON:TRCS)

In this article we are going to estimate the intrinsic value of Tracsis plc (LON:TRCS) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Tracsis

The method

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

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

Levered FCF (£, Millions)

UK£9.50m

UK£11.5m

UK£11.4m

UK£11.3m

UK£11.4m

UK£11.4m

UK£11.5m

UK£11.6m

UK£11.7m

UK£11.8m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ -0.98%

Est @ -0.32%

Est @ 0.14%

Est @ 0.46%

Est @ 0.69%

Est @ 0.85%

Est @ 0.96%

Est @ 1.04%

Present Value (£, Millions) Discounted @ 8.0%

UK£8.8

UK£9.9

UK£9.0

UK£8.3

UK£7.7

UK£7.2

UK£6.7

UK£6.3

UK£5.9

UK£5.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£75m

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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = UK£12m× (1 + 1.2%) ÷ (8.0%– 1.2%) = UK£177m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£177m÷ ( 1 + 8.0%)10= UK£82m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£157m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£6.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

AIM:TRCS Discounted Cash Flow June 26th 2020
AIM:TRCS Discounted Cash Flow June 26th 2020

The 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 Tracsis 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 8.0%, which is based on a levered beta of 0.977. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Tracsis, we've compiled three important factors you should consider:

  1. Risks: You should be aware of the 2 warning signs for Tracsis we've uncovered before considering an investment in the company.

  2. Future Earnings: How does TRCS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks just search here.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.

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