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A Look At The Fair Value Of ZOO Digital Group plc (LON:ZOO)

Key Insights

  • ZOO Digital Group's estimated fair value is UK£2.16 based on 2 Stage Free Cash Flow to Equity

  • Current share price of UK£2.08 suggests ZOO Digital Group is potentially trading close to its fair value

  • Our fair value estimate is 25% higher than ZOO Digital Group's analyst price target of US$2.70

In this article we are going to estimate the intrinsic value of ZOO Digital Group plc (LON:ZOO) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 ZOO Digital Group

The Method

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$5.96m

US$8.26m

US$13.2m

US$13.9m

US$16.1m

US$17.6m

US$18.8m

US$19.8m

US$20.5m

US$21.2m

Growth Rate Estimate Source

Analyst x5

Analyst x5

Analyst x2

Analyst x1

Analyst x1

Est @ 9.40%

Est @ 6.92%

Est @ 5.19%

Est @ 3.98%

Est @ 3.13%

Present Value ($, Millions) Discounted @ 8.2%

US$5.5

US$7.1

US$10.4

US$10.2

US$10.8

US$11.0

US$10.8

US$10.5

US$10.1

US$9.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$96m

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 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$21m× (1 + 1.2%) ÷ (8.2%– 1.2%) = US$304m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$304m÷ ( 1 + 8.2%)10= US$139m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$235m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£2.1, the company appears about fair value at a 3.9% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 ZOO Digital 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 8.2%, which is based on a levered beta of 1.010. 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 ZOO Digital Group

Strength

  • Currently debt free.

Weakness

  • No major weaknesses identified for ZOO.

Opportunity

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

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

Threat

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

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for 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. For ZOO Digital Group, we've compiled three important elements you should consider:

  1. Financial Health: Does ZOO 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.

  2. Future Earnings: How does ZOO'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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