A Look At The Intrinsic Value Of Synthomer plc (LON:SYNT)

Key Insights

• The projected fair value for Synthomer is UK£2.33 based on 2 Stage Free Cash Flow to Equity

• With UK£2.04 share price, Synthomer appears to be trading close to its estimated fair value

• The UK£26.20 analyst price target for SYNT is 1,024% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Synthomer plc (LON:SYNT) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Synthomer

The Calculation

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. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£55.1m	UK£76.1m	UK£60.0m	UK£51.3m	UK£46.4m	UK£43.5m	UK£41.8m	UK£40.8m	UK£40.3m	UK£40.2m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -21.20%	Est @ -14.39%	Est @ -9.61%	Est @ -6.27%	Est @ -3.94%	Est @ -2.30%	Est @ -1.15%	Est @ -0.35%
Present Value (£, Millions) Discounted @ 13%	UK£48.6	UK£59.2	UK£41.2	UK£31.1	UK£24.8	UK£20.5	UK£17.4	UK£15.0	UK£13.1	UK£11.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£282m

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 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£40m× (1 + 1.5%) ÷ (13%– 1.5%) = UK£345m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£345m÷ ( 1 + 13%)¹⁰= UK£99m

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£381m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£2.0, the company appears about fair value at a 12% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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. 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 Synthomer 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 13%, which is based on a levered beta of 2.000. 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 Synthomer

Strength

• Debt is well covered by cash flow.

Weakness

• Interest payments on debt are not well covered.

• Shareholders have been diluted in the past year.

Opportunity

• Forecast to reduce losses next year.

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

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

• Significant insider buying over the past 3 months.

Threat

• No apparent threats visible for SYNT.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Synthomer, there are three pertinent items you should consider:

1. Risks: Take risks, for example - Synthomer has 3 warning signs we think you should be aware of.

2. Future Earnings: How does SYNT'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.