A Look At The Fair Value Of Cryosite Limited (ASX:CTE)

Key Insights

• Cryosite's estimated fair value is AU$0.75 based on 2 Stage Free Cash Flow to Equity

• Cryosite's AU$0.63 share price indicates it is trading at similar levels as its fair value estimate

• The average premium for Cryosite's competitorsis currently 71%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Cryosite Limited (ASX:CTE) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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

Check out our latest analysis for Cryosite

Is Cryosite 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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$1.06m	AU$1.25m	AU$1.41m	AU$1.55m	AU$1.66m	AU$1.76m	AU$1.84m	AU$1.91m	AU$1.98m	AU$2.04m
Growth Rate Estimate Source	Est @ 24.13%	Est @ 17.54%	Est @ 12.93%	Est @ 9.70%	Est @ 7.44%	Est @ 5.85%	Est @ 4.74%	Est @ 3.97%	Est @ 3.43%	Est @ 3.05%
Present Value (A$, Millions) Discounted @ 6.6%	AU$1.0	AU$1.1	AU$1.2	AU$1.2	AU$1.2	AU$1.2	AU$1.2	AU$1.2	AU$1.1	AU$1.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$11m

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$2.0m× (1 + 2.2%) ÷ (6.6%– 2.2%) = AU$47m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$47m÷ ( 1 + 6.6%)¹⁰= AU$25m

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$36m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$0.6, the company appears about fair value at a 15% 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

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. 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 Cryosite 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 6.6%, which is based on a levered beta of 0.960. 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 Cryosite

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year is below its 5-year average.

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

Opportunity

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

• Significant insider buying over the past 3 months.

• Lack of analyst coverage makes it difficult to determine CTE's earnings prospects.

Threat

• No apparent threats visible for CTE.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Cryosite, we've compiled three fundamental aspects you should further research:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Cryosite .

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CTE'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. 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.