Is There An Opportunity With Micro Focus International plc’s (LON:MCRO) 31.35% Undervaluation?
Does the share price for Micro Focus International plc (LSE:MCRO) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value using the discounted cash flow (DCF) method. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in February 2018 so be sure check the latest calculation for Micro Focus International here.
What’s the value?
I will be using the 2-stage growth 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, I pulled together the analyst consensus estimates of MCRO’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 8.3%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of $3,671.1M. Keen to understand how I arrived at this number? Take a look at our detailed analysis here.
In the visual above, we see how how MCRO’s earnings are expected to move going forward, which should give you an idea of MCRO’s outlook. Now we need to calculate the terminal value, which accounts for all the future cash flows after the five years. It’s appropriate to use the 10-year government bond rate of 2.8% as the steady growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of $14,440.4M.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is $18,111.5M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of £29.85, which, compared to the current share price of £20.49, we find that Micro Focus International is quite undervalued at a 31.35% discount to what it is available for right now.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For MCRO, there are three essential aspects you should look at:
1. Financial Health: Does MCRO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does MCRO’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.
2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MCRO? 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 for every stock on the LSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
