# Is There An Opportunity With SEEK Limited's (ASX:SEK) 22% Undervaluation?

Simply Wall St
·6-min read

In this article we are going to estimate the intrinsic value of SEEK Limited (ASX:SEK) by taking the expected future cash flows and discounting them to their present value. I will be 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. 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.

Check out our latest analysis for SEEK

### 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 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

#### 10-year free cash flow (FCF) forecast

 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Levered FCF (A\$, Millions) AU\$183.3m AU\$221.7m AU\$273.0m AU\$359.5m AU\$453.5m AU\$522.4m AU\$579.6m AU\$625.9m AU\$662.9m AU\$692.5m Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x2 Analyst x2 Analyst x2 Est @ 15.18% Est @ 10.95% Est @ 7.99% Est @ 5.92% Est @ 4.47% Present Value (A\$, Millions) Discounted @ 7.7% AU\$170 AU\$191 AU\$218 AU\$267 AU\$312 AU\$334 AU\$344 AU\$345 AU\$339 AU\$329

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU\$2.8b

After calculating the present value of future cash flows in the intial 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 10-year government bond rate of 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF2029 Ã— (1 + g) Ã· (r â€“ g) = AU\$693mÃ— (1 + 1.1%) Ã· 7.7%â€“ 1.1%) = AU\$11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU\$11bÃ· ( 1 + 7.7%)10= AU\$5.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU\$7.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU\$17.3, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

### The assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 SEEK 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 7.7%, 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.

### Next Steps:

Although the valuation of a company is important, it shouldnâ€™t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price to differ from the intrinsic value? For SEEK, There are three fundamental aspects you should further research:

1. Risks: Every company has them, and we've spotted 2 warning signs for SEEK you should know about.

2. Future Earnings: How does SEK'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. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.