A Look At The Fair Value Of Silk Logistics Holdings Limited (ASX:SLH)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Silk Logistics Holdings fair value estimate is AU$1.72

• Silk Logistics Holdings' AU$1.52 share price indicates it is trading at similar levels as its fair value estimate

• The AU$2.37 analyst price target for SLH is 38% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Silk Logistics Holdings Limited (ASX:SLH) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Silk Logistics Holdings

Step By Step Through The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$12.6m	AU$16.2m	AU$23.1m	AU$17.7m	AU$14.9m	AU$13.4m	AU$12.5m	AU$12.0m	AU$11.7m	AU$11.6m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ -23.30%	Est @ -15.67%	Est @ -10.32%	Est @ -6.57%	Est @ -3.95%	Est @ -2.12%	Est @ -0.84%
Present Value (A$, Millions) Discounted @ 11%	AU$11.3	AU$13.2	AU$17.0	AU$11.8	AU$9.0	AU$7.3	AU$6.1	AU$5.3	AU$4.7	AU$4.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$90m

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. 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 (2.2%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$12m× (1 + 2.2%) ÷ (11%– 2.2%) = AU$139m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$139m÷ ( 1 + 11%)¹⁰= AU$50m

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$140m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$1.5, the company appears about fair value at a 12% 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

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. 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 Silk Logistics 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 11%, which is based on a levered beta of 1.858. 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 Silk Logistics Holdings

Strength

• Debt is well covered by cash flow.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

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

• Shareholders have been diluted in the past year.

Opportunity

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

• Good value based on P/E ratio and estimated fair value.

• Significant insider buying over the past 3 months.

Threat

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

Next Steps:

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. 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. For Silk Logistics Holdings, we've compiled three essential factors you should explore:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 5 warning signs with Silk Logistics Holdings (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

2. Future Earnings: How does SLH'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

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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.