Are Gentrack Group Limited (NZSE:GTK) Investors Paying Above The Intrinsic Value?

Key Insights

• Gentrack Group's estimated fair value is NZ$7.38 based on 2 Stage Free Cash Flow to Equity

• Current share price of NZ$9.74 suggests Gentrack Group is potentially 32% overvalued

• The NZ$9.50 analyst price target for GTK is 29% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Gentrack Group Limited (NZSE:GTK) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 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.

View our latest analysis for Gentrack Group

Is Gentrack Group Fairly Valued?

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. 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, 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 (NZ$, Millions)	NZ$18.2m	NZ$27.9m	NZ$31.9m	NZ$35.0m	NZ$37.6m	NZ$39.8m	NZ$41.8m	NZ$43.6m	NZ$45.3m	NZ$46.9m
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x3	Est @ 9.49%	Est @ 7.44%	Est @ 6.01%	Est @ 5.01%	Est @ 4.31%	Est @ 3.82%	Est @ 3.47%
Present Value (NZ$, Millions) Discounted @ 7.3%	NZ$16.9	NZ$24.3	NZ$25.9	NZ$26.4	NZ$26.5	NZ$26.2	NZ$25.6	NZ$24.9	NZ$24.1	NZ$23.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$244m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.7%) 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 7.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$47m× (1 + 2.7%) ÷ (7.3%– 2.7%) = NZ$1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$1.0b÷ ( 1 + 7.3%)¹⁰= NZ$520m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$764m. 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$9.7, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important 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 Gentrack 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 7.3%, which is based on a levered beta of 0.998. 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 Gentrack Group

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

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

Opportunity

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

Threat

• Revenue is forecast to grow slower than 20% per year.

Moving On:

Although the valuation of a company is important, it 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Gentrack Group, there are three additional elements you should consider:

1. Risks: To that end, you should be aware of the 3 warning signs we've spotted with Gentrack Group .

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GTK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. 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!

PS. Simply Wall St updates its DCF calculation for every New Zealander 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.