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Estimating The Intrinsic Value Of LGI Limited (ASX:LGI)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, LGI fair value estimate is AU$2.56

  • With AU$2.33 share price, LGI appears to be trading close to its estimated fair value

  • The average premium for LGI's competitorsis currently 215%

In this article we are going to estimate the intrinsic value of LGI Limited (ASX:LGI) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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

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Check out our latest analysis for LGI

Crunching The Numbers

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (A$, Millions)

-AU$450.0k

AU$1.45m

AU$2.64m

AU$4.16m

AU$5.87m

AU$7.59m

AU$9.20m

AU$10.6m

AU$11.8m

AU$12.8m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Est @ 81.75%

Est @ 57.83%

Est @ 41.08%

Est @ 29.36%

Est @ 21.15%

Est @ 15.41%

Est @ 11.39%

Est @ 8.58%

Present Value (A$, Millions) Discounted @ 6.0%

-AU$0.4

AU$1.3

AU$2.2

AU$3.3

AU$4.4

AU$5.3

AU$6.1

AU$6.7

AU$7.0

AU$7.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$43m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.0%) 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 6.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$13m× (1 + 2.0%) ÷ (6.0%– 2.0%) = AU$327m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$327m÷ ( 1 + 6.0%)10= AU$183m

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$226m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU$2.3, the company appears about fair value at a 8.8% 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
dcf

The 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 LGI 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 6.0%, which is based on a levered beta of 0.800. 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 LGI

Strength

  • Earnings growth over the past year exceeded the industry.

  • Currently debt free.

Weakness

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

Opportunity

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

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

Threat

  • No apparent threats visible for LGI.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For LGI, we've put together three fundamental aspects you should explore:

  1. Risks: We feel that you should assess the 1 warning sign for LGI we've flagged before making an investment in the company.

  2. Future Earnings: How does LGI'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. 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.