A Look At The Intrinsic Value Of The Lottery Corporation Limited (ASX:TLC)

Simply Wall St.10-17

Key Insights Lottery's estimated fair value is AU$4.69 based on 2 Stage Free Cash Flow to Equity Current share price of AU$5.12 suggests Lottery is potentially trading close to its fair value The...

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One way to achieve this is by employing the Discounted Cash Flow (DCF) model.  Don't get put off by the jargon, the math behind it is actually quite straightforward.  Remember though, that there are many ways to estimate a company's value, and a DCF is just one method.  If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.  See our latest analysis for Lottery  Crunching The Numbers   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) forecast  2025 2026 2027 2028 2029 2030 2031 2032 2033 2034  Levered FCF (A$, Millions)  AU$480.4m AU$499.0m AU$543.0m AU$541.0m AU$570.0m AU$589.8m AU$608.3m AU$626.1m AU$643.5m AU$660.6m Growth Rate Estimate Source Analyst x6 Analyst x6 Analyst x6 Analyst x1 Analyst x1 Est @ 3.47% Est @ 3.15% Est @ 2.93% Est @ 2.77% Est @ 2.66%  Present Value (A$, Millions) Discounted @ 7.4%  AU$447 AU$432 AU$438 AU$406 AU$398 AU$383 AU$368 AU$352 AU$337 AU$322 (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = AU$3.9b 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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%. Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$661m× (1 + 2.4%) ÷ (7.4%– 2.4%) = AU$13bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$13b÷ ( 1 + 7.4%)10= AU$6.5b The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value,  which in this case is AU$10b.  To get the intrinsic value per share, we divide this by the total number of shares outstanding.  Compared to the current share price of AU$5.1, the company appears   around fair value    at the time of writing.   Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. ASX:TLC Discounted Cash Flow October 17th 2024  The Assumptions  Now 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 Lottery 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 7.4%, which is based on a levered beta of 1.223. 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 LotteryStrength Earnings growth over the past year exceeded the industry. Debt is well covered by earnings and cashflows. Balance sheet summary for TLC. Weakness Dividend is low compared to the top 25% of dividend payers in the Hospitality market.Opportunity Annual earnings are forecast to grow for the next 3 years. Good value based on P/E ratio compared to estimated Fair P/E ratio. Threat Dividends are not covered by cash flow.  Annual earnings are forecast to grow slower than the Australian market.  See TLC's dividend history.  Moving On:  Although the valuation of a company is important, it  shouldn't be the only metric you look at when researching a company.  DCF models are not the be-all and end-all of investment valuation.  Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued.  For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.  For Lottery, there are three  essential  elements  you should look at:   Risks: For instance, we've identified   2 warning signs for Lottery  that you should be aware of.   Future Earnings: How does TLC'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 ASX every day. If you want to find the calculation for other stocks just search here.New: AI Stock Screener & AlertsOur new AI Stock Screener scans the market every day to uncover opportunities.• Dividend Powerhouses (3%+ Yield)• Undervalued Small Caps with Insider Buying• High growth Tech and AI CompaniesOr build your own from over 50 metrics.Explore Now for FreeHave 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. 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