Calculating The Fair Value Of Tamawood Limited (ASX:TWD)

Key Insights

• Tamawood's estimated fair value is AU$2.38 based on 2 Stage Free Cash Flow to Equity

• Current share price of AU$2.45 suggests Tamawood is potentially trading close to its fair value

• When compared to theindustry average discount of -2.3%, Tamawood's competitors seem to be trading at a lesser premium to fair value

Today we will run through one way of estimating the intrinsic value of Tamawood Limited (ASX:TWD) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Tamawood

The Calculation

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. 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$5.20m	AU$5.29m	AU$5.38m	AU$5.49m	AU$5.60m	AU$5.71m	AU$5.84m	AU$5.96m	AU$6.10m	AU$6.23m
Growth Rate Estimate Source	Est @ 1.31%	Est @ 1.59%	Est @ 1.79%	Est @ 1.93%	Est @ 2.03%	Est @ 2.10%	Est @ 2.15%	Est @ 2.18%	Est @ 2.20%	Est @ 2.22%
Present Value (A$, Millions) Discounted @ 8.0%	AU$4.8	AU$4.5	AU$4.3	AU$4.0	AU$3.8	AU$3.6	AU$3.4	AU$3.2	AU$3.1	AU$2.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$38m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$6.2m× (1 + 2.3%) ÷ (8.0%– 2.3%) = AU$112m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$112m÷ ( 1 + 8.0%)¹⁰= AU$52m

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$89m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 Tamawood 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 8.0%, which is based on a levered beta of 1.242. 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 Tamawood

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

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

• Shareholders have been diluted in the past year.

Opportunity

• TWD's financial characteristics indicate limited near-term opportunities for shareholders.

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

Threat

• Dividends are not covered by earnings and cashflows.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Tamawood, we've compiled three further items you should consider:

1. Risks: For example, we've discovered 4 warning signs for Tamawood (2 don't sit too well with us!) that you should be aware of before investing here.

2. 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!

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. 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.

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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.