Estimating The Intrinsic Value Of MotorCycle Holdings Limited (ASX:MTO)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, MotorCycle Holdings fair value estimate is AU$2.15

• Current share price of AU$2.03 suggests MotorCycle Holdings is potentially trading close to its fair value

• Our fair value estimate is 1.1% higher than MotorCycle Holdings' analyst price target of AU$2.12

Does the January share price for MotorCycle Holdings Limited (ASX:MTO) 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 their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for MotorCycle Holdings

What's The Estimated Valuation?

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 begin with, we have to get estimates of 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.

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$19.8m	AU$16.0m	AU$18.3m	AU$15.1m	AU$13.4m	AU$12.4m	AU$11.8m	AU$11.5m	AU$11.4m	AU$11.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ -17.39%	Est @ -11.55%	Est @ -7.46%	Est @ -4.60%	Est @ -2.59%	Est @ -1.19%	Est @ -0.21%
Present Value (A$, Millions) Discounted @ 9.4%	AU$18.1	AU$13.4	AU$14.0	AU$10.6	AU$8.6	AU$7.2	AU$6.3	AU$5.6	AU$5.1	AU$4.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$93m

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 (2.1%) 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 9.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$11m× (1 + 2.1%) ÷ (9.4%– 2.1%) = AU$159m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$159m÷ ( 1 + 9.4%)¹⁰= AU$65m

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. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$2.0, the company appears about fair value at a 5.5% 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.

ASX:MTO Discounted Cash Flow January 4th 2024

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. 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 MotorCycle Holdings 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 9.4%, which is based on a levered beta of 1.454. 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 MotorCycle Holdings

Strength

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

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

Weakness

• Earnings declined over the past year.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

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

Threat

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

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 MotorCycle Holdings, we've compiled three additional elements you should further research:

1. Risks: Take risks, for example - MotorCycle Holdings has 1 warning sign we think you should be aware of.

2. Future Earnings: How does MTO'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.

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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.