Key Insights

The projected fair value for Benchmark Holdings is UK£0.83 based on 2 Stage Free Cash Flow to Equity Benchmark Holdings' UK£0.42 share price signals that it might be 49% undervalued Our fair value estimate is 40% higher than Benchmark Holdings' analyst price target of UK£0.59

Today we will run through one way of estimating the intrinsic value of Benchmark Holdings plc (LON:BMK) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Benchmark Holdings

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (£, Millions)  UK£3.50m UK£10.1m UK£24.7m UK£39.6m UK£40.0m UK£40.4m UK£40.8m UK£41.3m UK£41.8m UK£42.3m Growth Rate Estimate Source Analyst x1 Analyst x2 Analyst x2 Analyst x2 Analyst x1 Est @ 1.02% Est @ 1.09% Est @ 1.13% Est @ 1.16% Est @ 1.19% Present Value (£, Millions) Discounted @ 6.8%  UK£3.3 UK£8.9 UK£20.3 UK£30.4 UK£28.8 UK£27.2 UK£25.7 UK£24.4 UK£23.1 UK£21.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£214m



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 6.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£42m× (1 + 1.2%) ÷ (6.8%– 1.2%) = UK£768m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£768m÷ ( 1 + 6.8%)10= UK£397m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£611m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.4, the company appears quite good value at a 49% 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

The Assumptions

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 Benchmark 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 6.8%, which is based on a levered beta of 0.800. 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 Benchmark Holdings

Strength

Debt is not viewed as a risk.

Weakness

Shareholders have been diluted in the past year.

Opportunity

Forecast to reduce losses next year.

Has sufficient cash runway for more than 3 years based on current free cash flows.

Trading below our estimate of fair value by more than 20%.

Significant insider buying over the past 3 months.

Threat

Not expected to become profitable over the next 3 years.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Benchmark Holdings, there are three pertinent elements you should consider:

Risks: Every company has them, and we've spotted  3 warning signs for Benchmark Holdings  you should know about. Future Earnings: How does BMK'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 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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