An Intrinsic Calculation For Sanderson Design Group plc (LON:SDG) Suggests It's 47% Undervalued
The projected fair value for Sanderson Design Group is UK£0.90 based on 2 Stage Free Cash Flow to Equity
Sanderson Design Group's UK£0.48 share price signals that it might be 47% undervalued
In this article we are going to estimate the intrinsic value of Sanderson Design Group plc (LON:SDG) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Sanderson Design Group
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (£, Millions)
-UK£5.92m
UK£7.05m
UK£6.70m
UK£6.53m
UK£6.45m
UK£6.45m
UK£6.49m
UK£6.56m
UK£6.66m
UK£6.77m
Growth Rate Estimate Source
Analyst x3
Analyst x2
Analyst x1
Est @ -2.59%
Est @ -1.12%
Est @ -0.10%
Est @ 0.62%
Est @ 1.13%
Est @ 1.48%
Est @ 1.72%
Present Value (£, Millions) Discounted @ 9.9%
-UK£5.4
UK£5.8
UK£5.0
UK£4.5
UK£4.0
UK£3.7
UK£3.3
UK£3.1
UK£2.8
UK£2.6
("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = UK£30m
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 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 9.9%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£6.8m× (1 + 2.3%) ÷ (9.9%– 2.3%) = UK£91m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£91m÷ ( 1 + 9.9%)10= UK£35m
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 UK£65m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£0.5, the company appears quite undervalued at a 47% 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.
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 Sanderson Design Group 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 9.9%, which is based on a levered beta of 1.489. 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.
Strength
Currently debt free.
Dividend is in the top 25% of dividend payers in the market.
Weakness
Earnings declined over the past year.
Opportunity
Trading below our estimate of fair value by more than 20%.
Threat
Paying a dividend but company has no free cash flows.
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Sanderson Design Group, there are three additional elements you should explore:
Risks: Be aware that Sanderson Design Group is showing 3 warning signs in our investment analysis , you should know about...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SDG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock 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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