How far off is South32 Limited (ASX:S32) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced using the discounted cash flows (DCF) model. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in January 2018 so be sure check the latest calculation for South32 here.
Crunching the numbers
I will be 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 perpetual stable growth rate. To start off, I use the analyst consensus forecast of S32’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 9.9%. This resulted in a present value of 5-year cash flow of $5,131.2M. Keen to know how I arrived at this number? Read our detailed analysis here.
The graph above shows how S32’s top and bottom lines are expected to move in the future, which should give you some color on S32’s outlook. Now we need to calculate the terminal value, which accounts for all the future cash flows after the five years. I’ve decided to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is $13,743.9M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $18,875.1M. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of A$4.65, which, compared to the current share price of A$3.65, we find that South32 is about right, perhaps slightly undervalued at a 21.49% discount to what it is available for right now.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For S32, I’ve put together three essential aspects you should further examine:
PS. Simply Wall St does a DCF calculation for every AU stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.