Yahoo Finance Estimating The Fair Value Of Alumina Limited (ASX:AWC)
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Alumina Limited (ASX:AWC) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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 and its not June 2018 then I highly recommend you check out the latest calculation for Alumina by following the link below. See our latest analysis for Alumina
What’s the value?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with we need to estimate the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
2018 | 2019 | 2020 | 2021 | 2022 | |
Levered FCF ($, Millions) | $468.15 | $394.25 | $413.87 | $352.03 | $408.35 |
Source | Analyst x3 | Analyst x5 | Analyst x4 | Analyst x1 | Extrapolated @ (16%, capped from 33.55%) |
Present Value Discounted @ 9.81% | $426.34 | $326.98 | $312.60 | $242.14 | $255.80 |
Present Value of 5-year Cash Flow (PVCF)= AU$1.56b
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 the GDP. In this case I have used the 10-year government bond rate (2.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.8%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = AU$408.35m × (1 + 2.8%) ÷ (9.8% – 2.8%) = AU$5.97b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = AU$5.97b ÷ ( 1 + 9.8%)5 = AU$3.74b
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 AU$5.30b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of $1.84. However, AWC’s primary listing is in Australia, and 1 share of AWC in USD represents 1.347 ( USD/ AUD) share of OTCPK:AWCM.Y, so the intrinsic value per share in AUD is A$2.48. Relative to the current share price of A$2.76, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Alumina as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.8%, which is based on a levered beta of 0.973. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
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 compiled three important aspects you should look at:
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.
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.
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!
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.
