Aussie Broadband Limited (ASX:ABB) Shares Could Be 25% Below Their Intrinsic Value Estimate

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Aussie Broadband fair value estimate is AU$4.79

• Aussie Broadband is estimated to be 25% undervalued based on current share price of AU$3.58

• The AU$3.57 analyst price target for ABB is 25% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Aussie Broadband Limited (ASX:ABB) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Aussie Broadband

The Method

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. 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.

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 (A$, Millions)	AU$19.2m	AU$33.8m	AU$55.4m	AU$54.2m	AU$53.8m	AU$53.8m	AU$54.2m	AU$54.7m	AU$55.5m	AU$56.4m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -2.08%	Est @ -0.84%	Est @ 0.04%	Est @ 0.65%	Est @ 1.08%	Est @ 1.38%	Est @ 1.59%
Present Value (A$, Millions) Discounted @ 6.1%	AU$18.1	AU$30.0	AU$46.4	AU$42.8	AU$40.0	AU$37.8	AU$35.8	AU$34.1	AU$32.6	AU$31.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$349m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$56m× (1 + 2.1%) ÷ (6.1%– 2.1%) = AU$1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$1.4b÷ ( 1 + 6.1%)¹⁰= AU$797m

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 AU$1.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$3.6, the company appears a touch undervalued at a 25% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf

Important 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Aussie Broadband 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 6.1%, which is based on a levered beta of 0.800. 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 Aussie Broadband

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is not viewed as a risk.

Weakness

• No major weaknesses identified for ABB.

Opportunity

• Annual earnings are forecast to grow faster than the Australian market.

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

Threat

• Revenue is forecast to grow slower than 20% per year.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Aussie Broadband, we've put together three additional elements you should assess:

1. Risks: Every company has them, and we've spotted 1 warning sign for Aussie Broadband you should know about.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ABB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. 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 ASX every day. If you want to find the calculation for other stocks 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.