Are Investors Undervaluing Skellerup Holdings Limited (NZSE:SKL) By 26%?

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editorial-team@simplywallst.com (Simply Wall St)

Wed, Nov 13, 2024, 11:46 AM 6 min read

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 expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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

Check out our latest analysis for Skellerup Holdings

Step By Step Through The Calculation

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (NZ$, Millions)	NZ$61.1m	NZ$57.4m	NZ$61.7m	NZ$62.0m	NZ$62.9m	NZ$64.0m	NZ$65.4m	NZ$66.9m	NZ$68.7m	NZ$70.5m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 0.57%	Est @ 1.29%	Est @ 1.80%	Est @ 2.16%	Est @ 2.41%	Est @ 2.58%	Est @ 2.70%
Present Value (NZ$, Millions) Discounted @ 7.2%	NZ$57.0	NZ$49.9	NZ$50.0	NZ$46.9	NZ$44.3	NZ$42.1	NZ$40.1	NZ$38.3	NZ$36.6	NZ$35.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$440m

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 (3.0%) 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)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = NZ$71m× (1 + 3.0%) ÷ (7.2%– 3.0%) = NZ$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$1.7b÷ ( 1 + 7.2%)¹⁰= NZ$851m

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$1.3b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of NZ$4.9, the company appears a touch undervalued at a 26% 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.

dcf — NZSE:SKL Discounted Cash Flow November 13th 2024

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 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 1.030. 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 Skellerup Holdings

Strength

Debt is not viewed as a risk.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Opportunity

Annual revenue is forecast to grow faster than the New Zealander market.

Trading below our estimate of fair value by more than 20%.

Threat

Dividends are not covered by earnings.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Skellerup Holdings, we've put together three additional aspects you should explore:

Risks: As an example, we've found 1 warning sign for Skellerup Holdings that you need to consider before investing here.
Future Earnings: How does SKL'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.
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. Simply Wall St updates its DCF calculation for every New Zealander stock every day, so if you want to find the intrinsic value of any other stock 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.