Is There An Opportunity With IPD Group Limited's (ASX:IPG) 38% Undervaluation?

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2 days ago

IPD Group's estimated fair value is AU$4.90 based on 2 Stage Free Cash Flow to Equity
Current share price of AU$3.06 suggests IPD Group is potentially 38% undervalued
The AU$4.24 analyst price target for IPG is 13% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of IPD Group Limited (ASX:IPG) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
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We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (A$, Millions)
AU$30.0m
AU$23.0m
AU$31.7m
AU$30.2m
AU$29.4m
AU$29.2m
AU$29.3m
AU$29.6m
AU$30.1m
AU$30.7m
Growth Rate Estimate Source
Analyst x4
Analyst x4
Analyst x3
Est @ -4.75%
Est @ -2.44%
Est @ -0.82%
Est @ 0.31%
Est @ 1.10%
Est @ 1.66%
Est @ 2.04%
Present Value (A$, Millions) Discounted @ 7.8%
AU$27.8
AU$19.8
AU$25.3
AU$22.4
AU$20.2
AU$18.6
AU$17.3
AU$16.3
AU$15.3
AU$14.5
("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = AU$198m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$31m× (1 + 2.9%) ÷ (7.8%– 2.9%) = AU$656m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$656m÷ ( 1 + 7.8%)10= AU$311m
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$508m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$3.1, the company appears quite undervalued at a 38% 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.
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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 IPD 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 7.8%, which is based on a levered beta of 1.112. 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.
See our latest analysis for IPD Group
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Trade Distributors market.
Opportunity
Annual revenue is forecast to grow faster than the Australian market.
Trading below our estimate of fair value by more than 20%.
Threat
Annual earnings are forecast to grow slower than the Australian market.
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. Why is the intrinsic value higher than the current share price? For IPD Group, there are three pertinent elements you should further examine:
Financial Health: Does IPG 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.
Future Earnings: How does IPG'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.