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EBOS Group Limited's (NZSE:EBO) Intrinsic Value Is Potentially 44% Above Its Share Price

Key Insights

  • EBOS Group's estimated fair value is NZ$54.46 based on 2 Stage Free Cash Flow to Equity

  • Current share price of NZ$37.78 suggests EBOS Group is potentially 31% undervalued

  • Our fair value estimate is 43% higher than EBOS Group's analyst price target of AU$38.04

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of EBOS Group Limited (NZSE:EBO) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for EBOS Group

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, 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

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

Levered FCF (A$, Millions)

AU$388.4m

AU$345.2m

AU$344.8m

AU$368.0m

AU$366.7m

AU$369.0m

AU$373.6m

AU$380.1m

AU$387.9m

AU$396.8m

Growth Rate Estimate Source

Analyst x3

Analyst x3

Analyst x2

Analyst x2

Est @ -0.35%

Est @ 0.60%

Est @ 1.27%

Est @ 1.73%

Est @ 2.06%

Est @ 2.29%

Present Value (A$, Millions) Discounted @ 6.1%

AU$366

AU$307

AU$289

AU$290

AU$273

AU$258

AU$247

AU$236

AU$227

AU$219

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$2.7b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$397m× (1 + 2.8%) ÷ (6.1%– 2.8%) = AU$12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$12b÷ ( 1 + 6.1%)10= AU$6.8b

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$9.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NZ$37.8, the company appears quite undervalued at a 31% 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

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 EBOS 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 6.1%, 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.

SWOT Analysis for EBOS Group

Strength

  • Debt is well covered by earnings and cashflows.

Weakness

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

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

Opportunity

  • Annual earnings are forecast to grow for the next 4 years.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Dividends are not covered by cash flow.

  • Annual earnings are forecast to grow slower than the New Zealander market.

Next Steps:

Whilst important, the DCF calculation 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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For EBOS Group, we've compiled three fundamental items you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with EBOS Group , and understanding it should be part of your investment process.

  2. Future Earnings: How does EBO'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 NZSE 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.