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Calculating The Fair Value Of XRF Scientific Limited (ASX:XRF)

Key Insights

  • XRF Scientific's estimated fair value is AU$1.15 based on 2 Stage Free Cash Flow to Equity

  • XRF Scientific's AU$1.01 share price indicates it is trading at similar levels as its fair value estimate

Does the November share price for XRF Scientific Limited (ASX:XRF) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. There's really not all that much to it, even though it might appear quite complex.

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.

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Check out our latest analysis for XRF Scientific

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$8.80m

AU$8.70m

AU$8.69m

AU$8.74m

AU$8.83m

AU$8.94m

AU$9.08m

AU$9.24m

AU$9.41m

AU$9.58m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ -0.11%

Est @ 0.55%

Est @ 1.01%

Est @ 1.33%

Est @ 1.55%

Est @ 1.71%

Est @ 1.82%

Est @ 1.90%

Present Value (A$, Millions) Discounted @ 7.1%

AU$8.2

AU$7.6

AU$7.1

AU$6.6

AU$6.2

AU$5.9

AU$5.6

AU$5.3

AU$5.1

AU$4.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$62m

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 7.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$9.6m× (1 + 2.1%) ÷ (7.1%– 2.1%) = AU$193m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$193m÷ ( 1 + 7.1%)10= AU$97m

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$159m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$1.0, the company appears about fair value at a 13% discount to where the stock price trades currently. 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.

dcf
dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 XRF Scientific 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 7.1%, which is based on a levered beta of 1.014. 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 XRF Scientific

Strength

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings growth over the past year underperformed the Machinery industry.

  • Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Opportunity

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

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

Threat

  • No apparent threats visible for XRF.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For XRF Scientific, we've compiled three further elements you should further research:

  1. Risks: You should be aware of the 2 warning signs for XRF Scientific we've uncovered before considering an investment in the company.

  2. Future Earnings: How does XRF'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. 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.