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Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Senetas Corporation Limited (ASX:SEN) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done 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. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.
View our latest analysis for Senetas
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. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF (A$, Millions) | A$5.30 | A$6.10 | A$6.90 | A$7.89 | A$9.02 |
| Source | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 14.33% | Est @ 14.33% |
| Present Value Discounted @ 9.18% | A$4.85 | A$5.12 | A$5.30 | A$5.55 | A$5.81 |
Present Value of 5-year Cash Flow (PVCF)= AU$27m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond 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 2.8%. We discount this to today’s value at a cost of equity of 9.2%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = AU$9m × (1 + 2.8%) ÷ (9.2% – 2.8%) = AU$145m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = AU$145m ÷ ( 1 + 9.2%)5 = AU$93m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is AU$120m. 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 A$0.11. Compared to the current share price of A$0.10, the stock is about right, perhaps slightly undervalued at a 9.8% discount to what it is available for right now.