Key Insights

MotorCycle Holdings' estimated fair value is AU$3.31 based on 2 Stage Free Cash Flow to Equity MotorCycle Holdings is estimated to be 48% undervalued based on current share price of AU$1.72 The AU$2.30 analyst price target for MTO is 30% less than our estimate of fair value

How far off is MotorCycle Holdings Limited (ASX:MTO) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for MotorCycle Holdings

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 begin with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$25.3m AU$24.4m AU$23.9m AU$23.8m AU$23.8m AU$24.0m AU$24.2m AU$24.5m AU$24.9m AU$25.3m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ -1.75% Est @ -0.64% Est @ 0.14% Est @ 0.69% Est @ 1.07% Est @ 1.34% Est @ 1.52% Est @ 1.65% Present Value (A$, Millions) Discounted @ 11%  AU$22.7 AU$19.8 AU$17.5 AU$15.6 AU$14.1 AU$12.8 AU$11.6 AU$10.6 AU$9.7 AU$8.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$143m

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 11%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$25m× (1 + 2.0%) ÷ (11%– 2.0%) = AU$285m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$285m÷ ( 1 + 11%)10= AU$100m

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$244m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$1.7, the company appears quite good value at a 48% 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

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. 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 MotorCycle Holdings 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 11%, which is based on a levered beta of 1.526. 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 MotorCycle Holdings

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 revenue is forecast to grow faster than the Australian market.

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

Threat

Debt is not well covered by operating cash flow.

Dividends are not covered by cash flow.

Annual earnings are forecast to grow slower than the Australian market.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For MotorCycle Holdings, we've put together three essential elements you should further examine:

Risks: For example, we've discovered 5 warning signs for MotorCycle Holdings (1 is concerning!) that you should be aware of before investing here. Future Earnings: How does MTO'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. 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.

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