An Intrinsic Calculation For Channel Infrastructure NZ Limited (NZSE:CHI) Suggests It's 42% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Channel Infrastructure NZ fair value estimate is NZ$2.49

• Channel Infrastructure NZ's NZ$1.44 share price signals that it might be 42% undervalued

• Analyst price target for CHI is NZ$1.69 which is 32% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Channel Infrastructure NZ Limited (NZSE:CHI) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Channel Infrastructure NZ

The Model

We're 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 a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NZ$, Millions)	NZ$64.8m	NZ$77.3m	NZ$77.0m	NZ$82.9m	NZ$76.4m	NZ$73.0m	NZ$71.2m	NZ$70.6m	NZ$70.7m	NZ$71.3m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ -4.48%	Est @ -2.37%	Est @ -0.89%	Est @ 0.14%	Est @ 0.86%
Present Value (NZ$, Millions) Discounted @ 9.1%	NZ$59.4	NZ$65.0	NZ$59.3	NZ$58.6	NZ$49.5	NZ$43.3	NZ$38.8	NZ$35.2	NZ$32.3	NZ$29.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$471m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$71m× (1 + 2.6%) ÷ (9.1%– 2.6%) = NZ$1.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$1.1b÷ ( 1 + 9.1%)¹⁰= NZ$469m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is NZ$941m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NZ$1.4, the company appears quite undervalued at a 42% 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.

NZSE:CHI Discounted Cash Flow March 18th 2024

The Assumptions

We would point out that 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 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 Channel Infrastructure NZ 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 9.1%, which is based on a levered beta of 1.420. 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 Channel Infrastructure NZ

Strength

• Earnings growth over the past year exceeded the industry.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Interest payments on debt are not well covered.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

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

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by earnings.

• Annual earnings are forecast to grow slower than the New Zealander market.

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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Channel Infrastructure NZ, we've compiled three relevant elements you should consider:

1. Risks: For instance, we've identified 2 warning signs for Channel Infrastructure NZ that you should be aware of.

2. Future Earnings: How does CHI'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.

3. 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.