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A Look At The Intrinsic Value Of Vulcan Steel Limited (ASX:VSL)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Vulcan Steel fair value estimate is AU$6.97

  • Current share price of AU$7.21 suggests Vulcan Steel is potentially trading close to its fair value

  • The NZ$7.85 analyst price target for VSL is 13% more than our estimate of fair value

Does the June share price for Vulcan Steel Limited (ASX:VSL) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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View our latest analysis for Vulcan Steel

What's The Estimated Valuation?

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 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.

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (NZ$, Millions)

NZ$111.1m

NZ$83.4m

NZ$118.6m

NZ$94.0m

NZ$81.0m

NZ$73.7m

NZ$69.6m

NZ$67.3m

NZ$66.2m

NZ$65.9m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Est @ -20.73%

Est @ -13.83%

Est @ -9.01%

Est @ -5.63%

Est @ -3.26%

Est @ -1.60%

Est @ -0.44%

Present Value (NZ$, Millions) Discounted @ 9.0%

NZ$102

NZ$70.2

NZ$91.7

NZ$66.7

NZ$52.7

NZ$44.0

NZ$38.1

NZ$33.9

NZ$30.6

NZ$27.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$558m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = NZ$66m× (1 + 2.3%) ÷ (9.0%– 2.3%) = NZ$1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$1.0b÷ ( 1 + 9.0%)10= NZ$426m

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$984m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$7.2, the company appears around fair value at the time of writing. 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
dcf

The 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 Vulcan Steel 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 9.0%, which is based on a levered beta of 1.458. 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 Vulcan Steel

Strength

  • Debt is well covered by earnings and cashflows.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.

Opportunity

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

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Dividends are not covered by earnings.

  • Annual revenue is forecast to grow slower than the Australian market.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Vulcan Steel, we've put together three relevant elements you should explore:

  1. Risks: Be aware that Vulcan Steel is showing 3 warning signs in our investment analysis , you should know about...

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for VSL's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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 ASX every day. If you want to find the calculation for other stocks just search here.

Have 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. Simply Wall St has no position in any stocks mentioned.