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Calculating The Fair Value Of MLG Oz Limited (ASX:MLG)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, MLG Oz fair value estimate is AU$0.74

  • MLG Oz's AU$0.62 share price indicates it is trading at similar levels as its fair value estimate

In this article we are going to estimate the intrinsic value of MLG Oz Limited (ASX:MLG) 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. 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. 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.

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View our latest analysis for MLG Oz

Crunching The Numbers

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. 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.

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) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$10.8m

AU$8.60m

AU$11.0m

AU$9.67m

AU$8.91m

AU$8.48m

AU$8.25m

AU$8.15m

AU$8.13m

AU$8.17m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Est @ -12.10%

Est @ -7.82%

Est @ -4.83%

Est @ -2.73%

Est @ -1.26%

Est @ -0.24%

Est @ 0.48%

Present Value (A$, Millions) Discounted @ 9.1%

AU$9.9

AU$7.2

AU$8.5

AU$6.8

AU$5.8

AU$5.0

AU$4.5

AU$4.1

AU$3.7

AU$3.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$59m

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 (2.2%) 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 9.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$8.2m× (1 + 2.2%) ÷ (9.1%– 2.2%) = AU$120m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$120m÷ ( 1 + 9.1%)10= AU$50m

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$109m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.6, the company appears about fair value at a 16% 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
dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 MLG Oz 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 9.1%, which is based on a levered beta of 1.514. 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 MLG Oz

Strength

  • Debt is not viewed as a risk.

Weakness

  • Earnings declined over the past year.

Opportunity

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

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

Threat

  • No apparent threats visible for MLG.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. For MLG Oz, there are three pertinent items you should consider:

  1. Risks: As an example, we've found 2 warning signs for MLG Oz that you need to consider before investing here.

  2. Future Earnings: How does MLG'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.

  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.