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Are Investors Undervaluing Australian Vintage Ltd (ASX:AVG) By 47%?

Key Insights

  • The projected fair value for Australian Vintage is AU$0.79 based on 2 Stage Free Cash Flow to Equity

  • Current share price of AU$0.42 suggests Australian Vintage is potentially 47% undervalued

  • Analyst price target for AVG is AU$0.47 which is 41% below our fair value estimate

How far off is Australian Vintage Ltd (ASX:AVG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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Check out our latest analysis for Australian Vintage

Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$1.20m

AU$7.50m

AU$8.85m

AU$9.85m

AU$10.7m

AU$11.4m

AU$12.0m

AU$12.5m

AU$13.0m

AU$13.4m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Analyst x2

Est @ 11.29%

Est @ 8.55%

Est @ 6.63%

Est @ 5.29%

Est @ 4.35%

Est @ 3.69%

Est @ 3.23%

Present Value (A$, Millions) Discounted @ 7.2%

AU$1.1

AU$6.5

AU$7.2

AU$7.4

AU$7.5

AU$7.5

AU$7.4

AU$7.2

AU$6.9

AU$6.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$65m

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 (2.2%) 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 7.2%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$13m× (1 + 2.2%) ÷ (7.2%– 2.2%) = AU$270m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$270m÷ ( 1 + 7.2%)10= AU$134m

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$200m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.4, the company appears quite good value at a 47% 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.

dcf
dcf

Important Assumptions

Now 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 Australian Vintage 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 7.2%, which is based on a levered beta of 1.102. 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 Australian Vintage

Strength

  • Debt is well covered by .

Weakness

  • Interest payments on debt are not well covered.

Opportunity

  • Expected to breakeven next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

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

Threat

  • Debt is not well covered by operating cash flow.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Australian Vintage, we've put together three further factors you should assess:

  1. Risks: Be aware that Australian Vintage is showing 1 warning sign in our investment analysis , you should know about...

  2. Future Earnings: How does AVG'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. 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.