Are Investors Undervaluing Tate & Lyle plc (LON:TATE) By 48%?

Key Insights

• Tate & Lyle's estimated fair value is UK£12.19 based on 2 Stage Free Cash Flow to Equity

• Tate & Lyle's UK£6.40 share price signals that it might be 48% undervalued

• The UK£8.75 analyst price target for TATE is 28% less than our estimate of fair value

How far off is Tate & Lyle plc (LON:TATE) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present 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 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 Tate & Lyle

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, 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)	UK£206.0m	UK£185.3m	UK£189.6m	UK£233.7m	UK£241.8m	UK£248.7m	UK£254.9m	UK£260.5m	UK£265.6m	UK£270.5m
Growth Rate Estimate Source	Analyst x5	Analyst x6	Analyst x6	Analyst x1	Est @ 3.46%	Est @ 2.88%	Est @ 2.47%	Est @ 2.19%	Est @ 1.99%	Est @ 1.85%
Present Value (£, Millions) Discounted @ 6.2%	UK£194	UK£164	UK£158	UK£183	UK£179	UK£173	UK£167	UK£160	UK£154	UK£148

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.7b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£271m× (1 + 1.5%) ÷ (6.2%– 1.5%) = UK£5.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£5.8b÷ ( 1 + 6.2%)¹⁰= UK£3.2b

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£4.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£6.4, the company appears quite good value at a 48% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Tate & Lyle 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 6.2%, which is based on a levered beta of 0.800. 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 Tate & Lyle

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

Weakness

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

Opportunity

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

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

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by cash flow.

• Annual earnings are forecast to grow slower than the British market.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Tate & Lyle, we've compiled three additional aspects you should look at:

1. Risks: For example, we've discovered 1 warning sign for Tate & Lyle that you should be aware of before investing here.

2. Future Earnings: How does TATE'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 Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

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.