Yahoo Finance Aussie Broadband Limited's (ASX:ABB) Intrinsic Value Is Potentially 22% Below Its Share Price
How far off is Aussie Broadband Limited (ASX:ABB) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Aussie Broadband
Step by step through the calculation
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. 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, 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) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF (A$, Millions) | AU$4.60m | AU$7.35m | AU$10.5m | AU$13.6m | AU$16.5m | AU$19.1m | AU$21.3m | AU$23.2m | AU$24.7m | AU$26.0m |
Growth Rate Estimate Source | Est @ 84.39% | Est @ 59.61% | Est @ 42.27% | Est @ 30.13% | Est @ 21.63% | Est @ 15.68% | Est @ 11.52% | Est @ 8.6% | Est @ 6.56% | Est @ 5.13% |
Present Value (A$, Millions) Discounted @ 5.2% | AU$4.4 | AU$6.6 | AU$9.0 | AU$11.1 | AU$12.8 | AU$14.1 | AU$15.0 | AU$15.5 | AU$15.7 | AU$15.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$119m
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 (1.8%) 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 5.2%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU$26m× (1 + 1.8%) ÷ (5.2%– 1.8%) = AU$779m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$779m÷ ( 1 + 5.2%)10= AU$470m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$589m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$3.2, the company appears slightly overvalued at the time of writing. 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
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 5.2%, 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.
Looking Ahead:
Although the valuation of a company is important, it 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. 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. What is the reason for the share price exceeding the intrinsic value? For Aussie Broadband, we've put together three relevant elements you should explore:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Aussie Broadband (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
Future Earnings: How does ABB'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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock 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.
