Is Chesterfield Special Cylinders Holdings Plc (LON:CSC) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Chesterfield Special Cylinders Holdings fair value estimate is UK£0.32
• Current share price of UK£0.41 suggests Chesterfield Special Cylinders Holdings is potentially 28% overvalued
• The average discount for Chesterfield Special Cylinders Holdings' competitorsis currently 37%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Chesterfield Special Cylinders Holdings Plc (LON:CSC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's 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.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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What's The Estimated Valuation?

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. To begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (£, Millions)	UK£45.0k	UK£600.0k	UK£600.0k	UK£605.4k	UK£614.6k	UK£626.7k	UK£640.9k	UK£656.9k	UK£674.2k	UK£692.7k
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 0.90%	Est @ 1.52%	Est @ 1.96%	Est @ 2.27%	Est @ 2.49%	Est @ 2.64%	Est @ 2.74%
Present Value (£, Millions) Discounted @ 7.2%	UK£0.04	UK£0.5	UK£0.5	UK£0.5	UK£0.4	UK£0.4	UK£0.4	UK£0.4	UK£0.4	UK£0.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£3.8m

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 3.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = UK£693k× (1 + 3.0%) ÷ (7.2%– 3.0%) = UK£17m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£17m÷ ( 1 + 7.2%)¹⁰= UK£8.6m

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£12m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£0.4, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important 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 Chesterfield Special Cylinders 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 7.2%, which is based on a levered beta of 0.817. 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.

Check out our latest analysis for Chesterfield Special Cylinders Holdings

SWOT Analysis for Chesterfield Special Cylinders Holdings

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For Chesterfield Special Cylinders Holdings, we've put together three essential items you should look at:

1. Risks: For instance, we've identified 1 warning sign for Chesterfield Special Cylinders Holdings that you should be aware of.
2. Future Earnings: How does CSC'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.

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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.