Orora Limited (ASX:ORA)’s intrinsic value may be 60% above its share price

Key findings

• The forecast fair value for Orora is AU$3.14 based on 2-step free cash flow to equity

• Orora’s share price of AU$1.97 suggests the company could be undervalued by 37%

• The analyst price target for ORA is AU$2.65, 15% below our fair value estimate.

Today we’ll run through a valuation methodology that estimates the attractiveness of Orora Limited (ASX:ORA) as an investment opportunity by estimating the company’s future cash flows and discounting them to their current value. One way to do this is by using the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they’re relatively simple to follow.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. For those who enjoy stock analysis, the analysis model from Simply Wall St listed here might be of interest.

Check out our latest analysis for Orora

The model

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = AU$1.7 billion

The story goes on

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.3%. We discount the terminal cash flows to today’s value at a cost of equity of 7.0%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$225 million × (1 + 2.3%) ÷ (7.0% – 2.3%) = AU$4.9 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= AU$4.9 billion ÷ ( 1 + 7.0 %)¹⁰= AU$2.5 billion

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is AU$4.2 billion. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.0, the company appears quite valuable at a 37% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this a rough estimate that isn’t accurate to the last cent.

The assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore does not provide a complete picture of a company’s potential performance. Since we are viewing Orora as prospective 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 takes debt into account. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.028. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Orora

Strength

weakness

Opportunity

Danger

Looking ahead:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. If a company grows at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome may be very different. Why is the intrinsic value higher than the current share price? For Orora, we have compiled three additional aspects that you should investigate further:

1. Risks: You should be aware 4 warning signs for Orora (3 are potentially serious!) that we uncovered before considering investing in the company.

2. management:Have insiders increased their shares to capitalize on market sentiment regarding ORA’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.

3. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS The Simply Wall St app does 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.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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