Tristel plc's (LON:TSTL) Intrinsic Value Is Potentially 21% Below Its Share Price
Key Insights
Tristel's estimated fair value is UK£3.70 based on 2 Stage Free Cash Flow to Equity
Tristel is estimated to be 27% overvalued based on current share price of UK£4.70
Analyst price target for TSTL is UK£4.82, which is 30% above our fair value estimate
Does the March share price for Tristel plc (LON:TSTL) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Tristel
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 begin with, we have to get estimates of 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, 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) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (£, Millions) | UK£6.39m | UK£7.24m | UK£8.84m | UK£9.20m | UK£9.51m | UK£9.77m | UK£10.0m | UK£10.2m | UK£10.4m | UK£10.6m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x2 | Est @ 4.04% | Est @ 3.32% | Est @ 2.82% | Est @ 2.46% | Est @ 2.22% | Est @ 2.04% | Est @ 1.92% |
Present Value (£, Millions) Discounted @ 6.7% | UK£6.0 | UK£6.4 | UK£7.3 | UK£7.1 | UK£6.9 | UK£6.6 | UK£6.4 | UK£6.1 | UK£5.8 | UK£5.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£64m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (1.6%) 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 6.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£11m× (1 + 1.6%) ÷ (6.7%– 1.6%) = UK£214m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£214m÷ ( 1 + 6.7%)10= UK£112m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£176m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£4.7, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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 Tristel 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 6.7%, which is based on a levered beta of 0.925. 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 Tristel
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual revenue is forecast to grow faster than the British market.
Threat
Dividends are not covered by earnings.
Annual earnings are forecast to grow slower than the British market.
Next Steps:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Tristel, we've put together three relevant factors you should further examine:
Risks: Take risks, for example - Tristel has 2 warning signs we think you should be aware of.
Future Earnings: How does TSTL'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 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. 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.
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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.
