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Orora Limited's (ASX:ORA) Intrinsic Value Is Potentially 60% Above Its Share Price

Key Insights

  • The projected fair value for Orora is AU$3.14 based on 2 Stage Free Cash Flow to Equity

  • Orora's AU$1.97 share price signals that it might be 37% undervalued

  • Analyst price target for ORA is AU$2.65 which is 15% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Orora Limited (ASX:ORA) 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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See our latest analysis for Orora

The Model

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. 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) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

AU$213.0m

AU$292.1m

AU$321.6m

AU$244.7m

AU$232.2m

AU$225.4m

AU$222.4m

AU$221.8m

AU$222.9m

AU$225.1m

Growth Rate Estimate Source

Analyst x3

Analyst x4

Analyst x4

Analyst x1

Est @ -5.12%

Est @ -2.91%

Est @ -1.36%

Est @ -0.27%

Est @ 0.49%

Est @ 1.02%

Present Value (A$, Millions) Discounted @ 7.0%

AU$199

AU$255

AU$263

AU$187

AU$166

AU$150

AU$139

AU$129

AU$121

AU$115

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.7b

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$225m× (1 + 2.3%) ÷ (7.0%– 2.3%) = AU$4.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$4.9b÷ ( 1 + 7.0%)10= AU$2.5b

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 AU$4.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.0, the company appears quite good value at a 37% 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

The Assumptions

Now 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 Orora 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 7.0%, which is based on a levered beta of 1.028. 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 Orora

Strength

  • Debt is well covered by earnings.

  • Dividend is in the top 25% of dividend payers in the market.

Weakness

  • Earnings declined over the past year.

  • Shareholders have been diluted in the past year.

Opportunity

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

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

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by earnings and cashflows.

  • Revenue is forecast to grow slower than 20% per year.

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. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. Why is the intrinsic value higher than the current share price? For Orora, we've put together three additional aspects you should further research:

  1. Risks: You should be aware of the 4 warning signs for Orora (3 are potentially serious!) we've uncovered before considering an investment in the company.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com