Calculating The Fair Value Of Novatti Group Limited (ASX:NOV)

Key Insights

• The projected fair value for Novatti Group is AU$0.11 based on 2 Stage Free Cash Flow to Equity

• Novatti Group's AU$0.12 share price indicates it is trading at similar levels as its fair value estimate

• When compared to theindustry average discount of -319%, Novatti Group's competitors seem to be trading at a greater premium to fair value

Does the September share price for Novatti Group Limited (ASX:NOV) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 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 Novatti Group

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$1.13m	AU$1.41m	AU$1.67m	AU$1.89m	AU$2.08m	AU$2.23m	AU$2.36m	AU$2.47m	AU$2.57m	AU$2.66m
Growth Rate Estimate Source	Est @ 34.76%	Est @ 24.94%	Est @ 18.06%	Est @ 13.24%	Est @ 9.87%	Est @ 7.51%	Est @ 5.86%	Est @ 4.71%	Est @ 3.90%	Est @ 3.33%
Present Value (A$, Millions) Discounted @ 7.7%	AU$1.1	AU$1.2	AU$1.3	AU$1.4	AU$1.4	AU$1.4	AU$1.4	AU$1.4	AU$1.3	AU$1.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$13m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.0%) 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 7.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$2.7m× (1 + 2.0%) ÷ (7.7%– 2.0%) = AU$48m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$48m÷ ( 1 + 7.7%)¹⁰= AU$23m

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$36m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.1, the company appears around fair value at the time of writing. 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

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 Novatti Group 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 7.7%, which is based on a levered beta of 1.136. 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 Novatti Group

Strength

• Cash in surplus of total debt.

Weakness

• Current share price is above our estimate of fair value.

Opportunity

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Lack of analyst coverage makes it difficult to determine NOV's earnings prospects.

Threat

• Debt is not well covered by operating cash flow.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Novatti Group, there are three important elements you should look at:

1. Risks: For example, we've discovered 2 warning signs for Novatti Group (1 can't be ignored!) that you should be aware of before investing here.

2. 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!

3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.