Are WAG plc (LON:WPS) payment solutions expensive for a reason? A look at its intrinsic value

Today we are going to give a simple overview of a valuation method used to estimate the attractiveness of WAG payment solutions plc (LON:WPS) as an investment opportunity by taking cash flow expected futures and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

Check out our latest analysis of WAG payment solutions

The model

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (€, Millions) €32.8 million €50.1 million €44.4 million €40.9 million €38.8 million €37.5 million €36.7 million €36.3 million €36.1 million €36.0 million
Growth rate estimate Source Analyst x2 Analyst x2 East @ -11.46% Is @ -7.75% East @ -5.16% Is @ -3.35% Is @ -2.08% Is @ -1.19% Is @ -0.57% East @ -0.14%
Present value (€, millions) discounted at 6.5% 30.8 € 44.2 € 36.8 € 31.9 € 28.4 € 25.8 € 23.7 € €22.0 20.6 € 19.3 €

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €283m

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (0.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.5%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €36m × (1 + 0.9%) ÷ (6.5%– 0.9%) = €652m

Present value of terminal value (PVTV)= TV / (1 + r)ten= €652m÷ ( 1 + 6.5%)ten= €349m

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 632 million euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.9, the company appears slightly overvalued at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.

LSE: WPS Discounted Cash Flow February 26, 2022

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider WAG payment solutions 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 factors in debt . In this calculation, we used 6.5%, which is based on a leveraged beta of 1.151. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While valuing a business is important, it ideally won’t be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Can we understand why the company is trading at a premium to its intrinsic value? For WAG payment solutions, we’ve put together three fundamental elements that you should consider in more detail:

  1. Risks: Be aware that WAG payment solutions display 2 warning signs in our investment analysis you should know…
  2. Future earnings: How does WPS’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every UK stock daily, so if you want to find the intrinsic value of any other stock, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

About Matthew R. Dailey

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