Is There An Opportunity With M.T.I Wireless Edge Ltd.'s (LON:MWE) 48% Undervaluation?
Key Insights
M.T.I Wireless Edge's estimated fair value is UK£0.71 based on 2 Stage Free Cash Flow to Equity
M.T.I Wireless Edge's UK£0.37 share price signals that it might be 48% undervalued
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of M.T.I Wireless Edge Ltd. (LON:MWE) as an investment opportunity 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.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 M.T.I Wireless Edge
What's The Estimated Valuation?
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) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$4.40m | US$4.54m | US$4.66m | US$4.77m | US$4.87m | US$4.96m | US$5.05m | US$5.14m | US$5.22m | US$5.31m |
Growth Rate Estimate Source | Est @ 3.88% | Est @ 3.17% | Est @ 2.68% | Est @ 2.33% | Est @ 2.09% | Est @ 1.92% | Est @ 1.80% | Est @ 1.71% | Est @ 1.66% | Est @ 1.62% |
Present Value ($, Millions) Discounted @ 7.3% | US$4.1 | US$3.9 | US$3.8 | US$3.6 | US$3.4 | US$3.2 | US$3.1 | US$2.9 | US$2.8 | US$2.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$33m
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. 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 7.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$5.3m× (1 + 1.5%) ÷ (7.3%– 1.5%) = US$93m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$93m÷ ( 1 + 7.3%)10= US$46m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$79m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.4, 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.
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. 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 M.T.I Wireless Edge 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 7.3%, which is based on a levered beta of 0.960. 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 M.T.I Wireless Edge
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend is in the top 25% of dividend payers in the market.
Weakness
Earnings growth over the past year is below its 5-year average.
Opportunity
Annual revenue is forecast to grow faster than the British market.
Trading below our estimate of fair value by more than 20%.
Threat
No apparent threats visible for MWE.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For M.T.I Wireless Edge, there are three important elements you should look at:
Risks: For instance, we've identified 2 warning signs for M.T.I Wireless Edge that you should be aware of.
Future Earnings: How does MWE'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM 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.
