Are Investors Undervaluing Mistras Group, Inc. (NYSE:MG) By 42%?

Key Insights

• The projected fair value for Mistras Group is US$11.43 based on 2 Stage Free Cash Flow to Equity

• Mistras Group is estimated to be 42% undervalued based on current share price of US$6.65

• Analyst price target for MG is US$9.33 which is 18% below our fair value estimate

Does the March share price for Mistras Group, Inc. (NYSE:MG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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.

Check out our latest analysis for Mistras Group

Crunching The Numbers

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$33.1m	US$31.3m	US$30.4m	US$29.9m	US$29.8m	US$29.9m	US$30.1m	US$30.5m	US$30.9m	US$31.5m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -3.01%	Est @ -1.48%	Est @ -0.42%	Est @ 0.33%	Est @ 0.85%	Est @ 1.22%	Est @ 1.47%	Est @ 1.65%
Present Value ($, Millions) Discounted @ 10%	US$30.1	US$25.8	US$22.7	US$20.4	US$18.4	US$16.8	US$15.4	US$14.1	US$13.0	US$12.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$189m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$31m× (1 + 2.1%) ÷ (10%– 2.1%) = US$400m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$400m÷ ( 1 + 10%)¹⁰= US$153m

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$342m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$6.7, the company appears quite good value at a 42% 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

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 Mistras 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 10%, which is based on a levered beta of 1.350. 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 Mistras Group

Strength

• Earnings growth over the past year exceeded the industry.

Weakness

• Interest payments on debt are not well covered.

Opportunity

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

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

Threat

• Debt is not well covered by operating cash flow.

• Annual revenue is forecast to grow slower than the American market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Why is the intrinsic value higher than the current share price? For Mistras Group, there are three relevant aspects you should explore:

1. Risks: Case in point, we've spotted 1 warning sign for Mistras Group you should be aware of.

2. Future Earnings: How does MG'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 American 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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here