Are Investors Undervaluing Likewise Group Plc (LON:LIKE) By 45%?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Likewise Group fair value estimate is UK£0.31

• Likewise Group is estimated to be 45% undervalued based on current share price of UK£0.17

• Likewise Group's peers seem to be trading at a higher discount to fair value based onthe industry average of 49%

Today we will run through one way of estimating the intrinsic value of Likewise Group Plc (LON:LIKE) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Likewise Group

Step By Step Through The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£7.20m	UK£6.40m	UK£5.95m	UK£5.68m	UK£5.53m	UK£5.46m	UK£5.43m	UK£5.44m	UK£5.47m	UK£5.52m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -7.09%	Est @ -4.47%	Est @ -2.64%	Est @ -1.35%	Est @ -0.46%	Est @ 0.17%	Est @ 0.61%	Est @ 0.92%
Present Value (£, Millions) Discounted @ 8.5%	UK£6.6	UK£5.4	UK£4.7	UK£4.1	UK£3.7	UK£3.3	UK£3.1	UK£2.8	UK£2.6	UK£2.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£39m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 8.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£5.5m× (1 + 1.6%) ÷ (8.5%– 1.6%) = UK£82m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£82m÷ ( 1 + 8.5%)¹⁰= UK£36m

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 UK£75m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£0.2, the company appears quite good value at a 45% discount to where the stock price trades currently. 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Likewise 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 8.5%, which is based on a levered beta of 1.251. 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 Likewise Group

Strength

• Net debt to equity ratio below 40%.

Weakness

• Interest payments on debt are not well covered.

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

Opportunity

• Expected to breakeven next year.

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

Threat

• Debt is not well covered by operating cash flow.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for 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 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 Likewise Group, there are three relevant aspects you should further research:

1. Risks: For example, we've discovered 2 warning signs for Likewise Group that you should be aware of before investing here.

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

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 British 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.