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Intrinsic Calculation For Mercury NZ Limited (NZSE:MCY) Shows Investors Are Overpaying

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Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Mercury NZ Limited (NZSE:MCY) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Mercury NZ by following the link below.

View our latest analysis for Mercury NZ

Step by step through the calculation

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. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow forecast

2019

2020

2021

2022

2023

Levered FCF (NZ$, Millions)

NZ$303.50

NZ$329.00

NZ$313.00

NZ$271.00

NZ$268.11

Source

Analyst x2

Analyst x2

Analyst x1

Analyst x1

Est @ -1.06%

Present Value Discounted @ 8.47%

NZ$279.79

NZ$279.60

NZ$245.23

NZ$195.73

NZ$178.52

Present Value of 5-year Cash Flow (PVCF)= NZ$1.2b

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The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.4%. We discount this to today’s value at a cost of equity of 8.5%.

Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = NZ$268m × (1 + 2.4%) ÷ (8.5% – 2.4%) = NZ$4.5b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = NZ$4.5b ÷ ( 1 + 8.5%)5 = NZ$3.0b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is NZ$4.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of NZ$3.06. Relative to the current share price of NZ$3.79, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

NZSE:MCY Intrinsic Value Export February 13th 19
NZSE:MCY Intrinsic Value Export February 13th 19

Important assumptions

I’d like to 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Mercury NZ as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.5%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For MCY, I’ve put together three important factors you should look at:

  1. Financial Health: Does MCY have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Future Earnings: How does MCY’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: Are there other high quality stocks you could be holding instead of MCY? 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 does a DCF calculation for every NZ stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.