Is There An Opportunity With Likewise Group Plc's (LON:LIKE) 46% Undervaluation?

Key Insights

• The projected fair value for Likewise Group is UK£0.29 based on 2 Stage Free Cash Flow to Equity

• Likewise Group's UK£0.16 share price signals that it might be 46% undervalued

• Likewise Group's peers seem to be trading at a higher discount to fair value based onthe industry average of 48%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Likewise Group Plc (LON:LIKE) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for Likewise Group

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. 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.

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 (£, Millions)	UK£7.20m	UK£6.40m	UK£5.94m	UK£5.67m	UK£5.51m	UK£5.42m	UK£5.39m	UK£5.38m	UK£5.40m	UK£5.44m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -7.17%	Est @ -4.60%	Est @ -2.81%	Est @ -1.55%	Est @ -0.67%	Est @ -0.06%	Est @ 0.37%	Est @ 0.68%
Present Value (£, Millions) Discounted @ 8.8%	UK£6.6	UK£5.4	UK£4.6	UK£4.1	UK£3.6	UK£3.3	UK£3.0	UK£2.8	UK£2.5	UK£2.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£38m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (1.4%) 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 8.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£5.4m× (1 + 1.4%) ÷ (8.8%– 1.4%) = UK£75m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£75m÷ ( 1 + 8.8%)¹⁰= UK£32m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£71m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£0.2, the company appears quite undervalued at a 46% 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

The 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 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 8.8%, which is based on a levered beta of 1.249. 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.

• Has less than 3 years of cash runway based on current free cash flow.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Likewise Group, we've compiled three pertinent factors you should further examine:

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

2. Future Earnings: How does LIKE'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 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.