Calculating The Intrinsic Value Of Steel & Tube Holdings Limited (NZSE:STU)

Key Insights

• Steel & Tube Holdings' estimated fair value is NZ$0.88 based on 2 Stage Free Cash Flow to Equity

• Steel & Tube Holdings' NZ$1.05 share price indicates it is trading at similar levels as its fair value estimate

• Industry average of 11% suggests Steel & Tube Holdings' peers are currently trading at a lower premium to fair value

Today we will run through one way of estimating the intrinsic value of Steel & Tube Holdings Limited (NZSE:STU) by projecting its future cash flows and then 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!

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.

View our latest analysis for Steel & Tube Holdings

Is Steel & Tube Holdings Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, 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 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, 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NZ$, Millions)	NZ$37.7m	NZ$6.20m	NZ$8.80m	NZ$16.7m	NZ$12.8m	NZ$10.7m	NZ$9.64m	NZ$9.02m	NZ$8.68m	NZ$8.52m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ -23.62%	Est @ -15.77%	Est @ -10.27%	Est @ -6.43%	Est @ -3.73%	Est @ -1.85%
Present Value (NZ$, Millions) Discounted @ 9.1%	NZ$34.6	NZ$5.2	NZ$6.8	NZ$11.8	NZ$8.3	NZ$6.4	NZ$5.2	NZ$4.5	NZ$4.0	NZ$3.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$90m

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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$8.5m× (1 + 2.6%) ÷ (9.1%– 2.6%) = NZ$134m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$134m÷ ( 1 + 9.1%)¹⁰= NZ$56m

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 NZ$146m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$1.1, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

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 Steel & Tube 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 9.1%, which is based on a levered beta of 1.422. 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 Steel & Tube Holdings

Strength

• Currently debt free.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Earnings declined over the past year.

• Current share price is above our estimate of fair value.

Opportunity

• Annual earnings are forecast to grow faster than the New Zealander market.

Threat

• Dividends are not covered by earnings.

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. 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. For Steel & Tube Holdings, we've put together three fundamental items you should look at:

1. Risks: Case in point, we've spotted 2 warning signs for Steel & Tube Holdings you should be aware of.

2. Future Earnings: How does STU'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 NZSE 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.