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An Intrinsic Calculation For Kelsian Group Limited (ASX:KLS) Suggests It's 42% Undervalued

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Kelsian Group fair value estimate is AU$9.83

  • Kelsian Group's AU$5.72 share price signals that it might be 42% undervalued

  • Our fair value estimate is 33% higher than Kelsian Group's analyst price target of AU$7.41

Today we will run through one way of estimating the intrinsic value of Kelsian Group Limited (ASX:KLS) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Kelsian Group

Is Kelsian Group Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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 (A$, Millions)

AU$82.3m

AU$109.9m

AU$134.0m

AU$147.6m

AU$162.2m

AU$172.9m

AU$182.0m

AU$189.9m

AU$196.7m

AU$202.8m

Growth Rate Estimate Source

Analyst x5

Analyst x4

Analyst x4

Analyst x3

Analyst x2

Est @ 6.66%

Est @ 5.26%

Est @ 4.29%

Est @ 3.60%

Est @ 3.13%

Present Value (A$, Millions) Discounted @ 7.9%

AU$76.3

AU$94.4

AU$107

AU$109

AU$111

AU$110

AU$107

AU$103

AU$99.1

AU$94.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.0b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$203m× (1 + 2.0%) ÷ (7.9%– 2.0%) = AU$3.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$3.5b÷ ( 1 + 7.9%)10= AU$1.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$2.6b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$5.7, the company appears quite good value at a 42% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Kelsian Group 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 7.9%, which is based on a levered beta of 1.181. 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 Kelsian Group

Strength

  • Debt is well covered by earnings.

Weakness

  • Earnings declined over the past year.

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

  • Shareholders have been diluted in the past year.

Opportunity

  • Annual earnings are forecast to grow faster than the Australian market.

  • 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 and cashflows.

  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Kelsian Group, we've put together three important elements you should assess:

  1. Risks: You should be aware of the 5 warning signs for Kelsian Group (2 shouldn't be ignored!) we've uncovered before considering an investment in the company.

  2. Future Earnings: How does KLS'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 Australian 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.