Are Investors Undervaluing Trainline Plc (LON:TRN) By 42%?

Simply Wall St · 09/15/2023 05:38

Key Insights

  • Trainline's estimated fair value is UK£4.78 based on 2 Stage Free Cash Flow to Equity
  • Trainline is estimated to be 42% undervalued based on current share price of UK£2.76
  • Analyst price target for TRN is UK£3.67 which is 23% below our fair value estimate

How far off is Trainline Plc (LON:TRN) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Trainline

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. 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.

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) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (£, Millions) UK£68.8m UK£75.3m UK£75.4m UK£109.0m UK£133.9m UK£152.1m UK£167.2m UK£179.5m UK£189.5m UK£197.7m
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x6 Analyst x1 Analyst x1 Est @ 13.59% Est @ 9.93% Est @ 7.36% Est @ 5.57% Est @ 4.31%
Present Value (£, Millions) Discounted @ 8.0% UK£63.7 UK£64.5 UK£59.9 UK£80.2 UK£91.2 UK£96.0 UK£97.7 UK£97.1 UK£95.0 UK£91.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£837m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£198m× (1 + 1.4%) ÷ (8.0%– 1.4%) = UK£3.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£3.0b÷ ( 1 + 8.0%)10= UK£1.4b

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 UK£2.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£2.8, the company appears quite undervalued at a 42% discount to where the stock price trades currently. 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.

dcf
LSE:TRN Discounted Cash Flow September 15th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Trainline 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 8.0%, which is based on a levered beta of 1.117. 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 Trainline

Strength
  • Debt is well covered by cash flow.
Weakness
  • Interest payments on debt are not well covered.
Opportunity
  • Annual earnings are forecast to grow faster than the British market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Revenue is forecast to grow slower than 20% per year.

Moving On:

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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Trainline, there are three pertinent factors you should look at:

  1. Risks: Case in point, we've spotted 1 warning sign for Trainline you should be aware of.
  2. Future Earnings: How does TRN'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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