Estimating The Fair Value Of Yunhong CTI Ltd. (NASDAQ:CTIB)

Key Insights

• Yunhong CTI's estimated fair value is US$2.27 based on 2 Stage Free Cash Flow to Equity

• Current share price of US$1.86 suggests Yunhong CTI is potentially trading close to its fair value

Does the May share price for Yunhong CTI Ltd. (NASDAQ:CTIB) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Yunhong CTI

Is Yunhong CTI 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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$2.61m	US$2.92m	US$3.18m	US$3.40m	US$3.58m	US$3.74m	US$3.88m	US$4.01m	US$4.13m	US$4.24m
Growth Rate Estimate Source	Est @ 15.94%	Est @ 11.79%	Est @ 8.89%	Est @ 6.86%	Est @ 5.43%	Est @ 4.44%	Est @ 3.74%	Est @ 3.25%	Est @ 2.91%	Est @ 2.67%
Present Value ($, Millions) Discounted @ 9.5%	US$2.4	US$2.4	US$2.4	US$2.4	US$2.3	US$2.2	US$2.1	US$1.9	US$1.8	US$1.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$22m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.1%) 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 9.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$4.2m× (1 + 2.1%) ÷ (9.5%– 2.1%) = US$59m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$59m÷ ( 1 + 9.5%)¹⁰= US$24m

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 US$45m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$1.9, 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Yunhong CTI 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 9.5%, which is based on a levered beta of 1.240. 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 Yunhong CTI

Strength

• Debt is well covered by earnings and cashflows.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

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

• Current share price is below our estimate of fair value.

• Lack of analyst coverage makes it difficult to determine CTIB's earnings prospects.

Threat

• No apparent threats visible for CTIB.

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Yunhong CTI, we've put together three additional factors you should explore:

1. Risks: For example, we've discovered 4 warning signs for Yunhong CTI (2 are significant!) that you should be aware of before investing here.

2. 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!

3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. Simply Wall St updates its DCF calculation for every American 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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