Calculating The Intrinsic Value Of Clarkson PLC (LON:CKN)

Key Insights

• The projected fair value for Clarkson is UK£25.64 based on 2 Stage Free Cash Flow to Equity

• Current share price of UK£28.30 suggests Clarkson is potentially trading close to its fair value

• Analyst price target for CKN is UK£43.04, which is 68% above our fair value estimate

In this article we are going to estimate the intrinsic value of Clarkson PLC (LON:CKN) by taking the expected future cash flows and discounting them to today's 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Clarkson

The Model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£69.7m	UK£72.0m	UK£58.9m	UK£51.7m	UK£47.5m	UK£44.9m	UK£43.5m	UK£42.6m	UK£42.2m	UK£42.1m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ -18.15%	Est @ -12.29%	Est @ -8.19%	Est @ -5.32%	Est @ -3.31%	Est @ -1.90%	Est @ -0.92%	Est @ -0.23%
Present Value (£, Millions) Discounted @ 6.8%	UK£65.2	UK£63.1	UK£48.4	UK£39.7	UK£34.1	UK£30.3	UK£27.4	UK£25.2	UK£23.4	UK£21.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£379m

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. 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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£42m× (1 + 1.4%) ÷ (6.8%– 1.4%) = UK£787m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£787m÷ ( 1 + 6.8%)¹⁰= UK£407m

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 UK£786m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£28.3, the company appears around fair value at the time of writing. 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

Important 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 Clarkson 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 6.8%, which is based on a levered beta of 0.919. 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 Clarkson

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Currently debt free.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year underperformed the Shipping industry.

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

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• CKN's financial characteristics indicate limited near-term opportunities for shareholders.

Threat

• Annual earnings are forecast to decline for the next 3 years.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Clarkson, there are three relevant factors you should consider:

1. Risks: Be aware that Clarkson is showing 2 warning signs in our investment analysis , and 1 of those is significant...

2. Future Earnings: How does CKN'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 LSE every day. If you want to find the calculation for other stocks just search here.

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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.