I am going to run you through how I calculated the intrinsic value of Alumina Limited (ASX:AWC) using the discounted cash flow (DCF) method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after May 2018 then I highly recommend you check out the latest calculation for Alumina here.
What’s the value?
I use what is known as the 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. Firstly, I took the analyst consensus forecast of AWC’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 9.72%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of US$1.57B. Want to know how I arrived at this number? Read our detailed analysis here.
Above is a visual representation of how AWC’s top and bottom lines are expected to move in the future, which should give you some color on AWC’s outlook. Next, I calculate the terminal value, which is the business’s cash flow after the first stage. I’ve decided to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes US$3.79B.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$5.36B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of A$2.46, which, compared to the current share price of A$2.72, we find that Alumina is fair value, maybe slightly overvalued and not available at a discount at this time.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company.
For AWC, I’ve put together three relevant aspects you should look at:
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Financial Health: Does AWC have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
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Future Earnings: How does AWC’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.
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Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of AWC? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!