A Look At The Intrinsic Value Of Norcros plc (LON:NXR)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Norcros fair value estimate is UK£1.72
With UK£1.82 share price, Norcros appears to be trading close to its estimated fair value
Our fair value estimate is 44% lower than Norcros' analyst price target of UK£3.08
In this article we are going to estimate the intrinsic value of Norcros plc (LON:NXR) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Norcros
The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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£18.6m | UK£22.6m | UK£17.5m | UK£15.5m | UK£14.4m | UK£13.7m | UK£13.3m | UK£13.1m | UK£13.0m | UK£13.0m |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x1 | Est @ -11.35% | Est @ -7.49% | Est @ -4.79% | Est @ -2.89% | Est @ -1.57% | Est @ -0.64% | Est @ 0.01% |
Present Value (£, Millions) Discounted @ 10% | UK£16.9 | UK£18.6 | UK£13.0 | UK£10.5 | UK£8.8 | UK£7.6 | UK£6.7 | UK£5.9 | UK£5.3 | UK£4.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£98m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (1.5%) 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 10%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£13m× (1 + 1.5%) ÷ (10%– 1.5%) = UK£149m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£149m÷ ( 1 + 10%)10= UK£56m
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£154m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£1.8, the company appears around fair value at the time of writing. 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Norcros 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 10%, which is based on a levered beta of 1.494. 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 Norcros
Strength
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Building market.
Opportunity
Annual earnings are forecast to grow faster than the British market.
Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
Annual revenue is expected to decline over the next 3 years.
Next Steps:
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. 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 Norcros, there are three relevant elements you should explore:
Risks: As an example, we've found 2 warning signs for Norcros that you need to consider before investing here.
Future Earnings: How does NXR'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.
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. 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.
