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Powerball's $150 million jackpot :

Winning numbers revealed

An Intrinsic Calculation For Ansell Limited (ASX:ANN) Suggests It's 38% Undervalued

Key Insights

  • Ansell's estimated fair value is AU$39.91 based on 2 Stage Free Cash Flow to Equity

  • Ansell's AU$24.58 share price signals that it might be 38% undervalued

  • Our fair value estimate is 58% higher than Ansell's analyst price target of US$25.22

Today we will run through one way of estimating the intrinsic value of Ansell Limited (ASX:ANN) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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See our latest analysis for Ansell

Is Ansell Fairly Valued?

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 ($, Millions)

US$182.1m

US$171.3m

US$167.9m

US$163.1m

US$169.5m

US$169.8m

US$171.2m

US$173.3m

US$175.9m

US$178.8m

Growth Rate Estimate Source

Analyst x4

Analyst x4

Analyst x4

Analyst x2

Analyst x2

Est @ 0.22%

Est @ 0.80%

Est @ 1.21%

Est @ 1.50%

Est @ 1.70%

Present Value ($, Millions) Discounted @ 6.8%

US$170

US$150

US$138

US$125

US$122

US$114

US$108

US$102

US$96.9

US$92.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2b

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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$179m× (1 + 2.2%) ÷ (6.8%– 2.2%) = US$3.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.9b÷ ( 1 + 6.8%)10= US$2.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$3.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$24.6, the company appears quite good value at a 38% 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

Important 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 Ansell 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 6.8%, which is based on a levered beta of 1.018. 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 Ansell

Strength

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings declined over the past year.

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

Opportunity

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

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

Threat

  • Annual revenue is forecast to grow slower than the Australian 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Ansell, we've compiled three additional elements you should look at:

  1. Risks: We feel that you should assess the 2 warning signs for Ansell we've flagged before making an investment in the company.

  2. Future Earnings: How does ANN'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 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. 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.

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.