Is There An Opportunity With TT Electronics plc’s (LON:TTG) 33% Undervaluation?

How far off is TT Electronics plc (LON:TTG) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they’re fairly easy to follow.

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 TT Electronics

The method

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. 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, 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

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF (£, Millions)

UK£18.1m

UK£26.9m

UK£33.7m

UK£39.7m

UK£44.8m

UK£49.0m

UK£52.3m

UK£54.9m

UK£57.0m

UK£58.7m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Est @ 25.36%

Est @ 18.02%

Est @ 12.88%

Est @ 9.29%

Est @ 6.77%

Est @ 5.01%

Est @ 3.78%

Est @ 2.91%

Present Value (£, Millions) Discounted @ 7.7%

UK£16.8

UK£23.1

UK£26.9

UK£29.5

UK£30.9

UK£31.4

UK£31.1

UK£30.3

UK£29.2

UK£27.9

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£277m

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (0.9%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 7.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r

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