Yahoo Finance Is There An Opportunity With Skellerup Holdings Limited's (NZSE:SKL) 41% Undervaluation?
How far off is Skellerup Holdings Limited (NZSE:SKL) 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 forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for Skellerup Holdings
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. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF (NZ$, Millions) | NZ$59.6m | NZ$67.3m | NZ$73.8m | NZ$79.3m | NZ$83.9m | NZ$87.8m | NZ$91.3m | NZ$94.4m | NZ$97.3m | NZ$100.0m |
Growth Rate Estimate Source | Est @ 17.53% | Est @ 12.91% | Est @ 9.68% | Est @ 7.42% | Est @ 5.84% | Est @ 4.73% | Est @ 3.95% | Est @ 3.41% | Est @ 3.03% | Est @ 2.76% |
Present Value (NZ$, Millions) Discounted @ 7.2% | NZ$55.6 | NZ$58.5 | NZ$59.9 | NZ$60.0 | NZ$59.2 | NZ$57.9 | NZ$56.1 | NZ$54.1 | NZ$52.0 | NZ$49.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$563m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.1%) 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 7.2%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NZ$100m× (1 + 2.1%) ÷ (7.2%– 2.1%) = NZ$2.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$2.0b÷ ( 1 + 7.2%)10= NZ$1.0b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$1.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of NZ$4.7, the company appears quite good value at a 41% 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.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Skellerup 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 7.2%, which is based on a levered beta of 1.073. 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.
Looking Ahead:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Skellerup Holdings, we've put together three fundamental elements you should consider:
Risks: Take risks, for example - Skellerup Holdings has 2 warning signs we think you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SKL's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.
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. 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.
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