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Are Investors Undervaluing Marlowe plc (LON:MRL) By 38%?

Key Insights

  • Marlowe's estimated fair value is UK£7.45 based on 2 Stage Free Cash Flow to Equity

  • Current share price of UK£4.60 suggests Marlowe is potentially 38% undervalued

  • The UK£10.93 analyst price target for MRL is 47% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Marlowe plc (LON:MRL) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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View our latest analysis for Marlowe

What's The Estimated Valuation?

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.

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:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (£, Millions)

UK£14.9m

UK£36.6m

UK£43.0m

UK£47.6m

UK£51.3m

UK£54.3m

UK£56.7m

UK£58.7m

UK£60.3m

UK£61.7m

Growth Rate Estimate Source

Analyst x4

Analyst x4

Analyst x3

Est @ 10.71%

Est @ 7.84%

Est @ 5.83%

Est @ 4.43%

Est @ 3.44%

Est @ 2.76%

Est @ 2.27%

Present Value (£, Millions) Discounted @ 8.1%

UK£13.7

UK£31.3

UK£34.0

UK£34.8

UK£34.7

UK£34.0

UK£32.8

UK£31.4

UK£29.9

UK£28.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£305m

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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£62m× (1 + 1.2%) ÷ (8.1%– 1.2%) = UK£894m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£894m÷ ( 1 + 8.1%)10= UK£409m

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£714m. 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£4.6, the company appears quite undervalued at a 38% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important Assumptions

Now 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 Marlowe 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 8.1%, which is based on a levered beta of 1.001. 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 Marlowe

Strength

  • Debt is well covered by earnings.

Weakness

  • No major weaknesses identified for MRL.

Opportunity

  • Annual earnings are forecast to grow faster than the British market.

  • Good value based on P/S ratio and estimated fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Marlowe, there are three further elements you should further examine:

  1. Risks: You should be aware of the 1 warning sign for Marlowe we've uncovered before considering an investment in the company.

  2. Future Earnings: How does MRL'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: 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 AIM 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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