Calculating The Fair Value Of Far East Orchard Limited (SGX:O10)

Simply Wall St
·6 min read

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Far East Orchard fair value estimate is S$1.29

  • Far East Orchard's S$1.04 share price indicates it is trading at similar levels as its fair value estimate

  • Far East Orchard's peers are currently trading at a premium of 36% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Far East Orchard Limited (SGX:O10) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Far East Orchard

The Calculation

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (SGD, Millions)

S$42.0m

S$51.0m

S$59.0m

S$65.9m

S$71.6m

S$76.3m

S$80.3m

S$83.7m

S$86.7m

S$89.4m

Growth Rate Estimate Source

Est @ 30.01%

Est @ 21.59%

Est @ 15.69%

Est @ 11.56%

Est @ 8.67%

Est @ 6.65%

Est @ 5.23%

Est @ 4.24%

Est @ 3.55%

Est @ 3.06%

Present Value (SGD, Millions) Discounted @ 13%

S$37.2

S$40.1

S$41.2

S$40.7

S$39.3

S$37.1

S$34.7

S$32.0

S$29.4

S$26.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S$359m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = S$89m× (1 + 1.9%) ÷ (13%– 1.9%) = S$841m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$841m÷ ( 1 + 13%)10= S$253m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is S$612m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of S$1.0, the company appears about fair value at a 19% 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
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 Far East Orchard 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 13%, which is based on a levered beta of 1.823. 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 Far East Orchard

Strength

  • Net debt to equity ratio below 40%.

  • 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 Real Estate market.

  • Shareholders have been diluted in the past year.

Opportunity

  • Current share price is below our estimate of fair value.

  • Lack of analyst coverage makes it difficult to determine O10's earnings prospects.

Threat

  • Debt is not well covered by operating cash flow.

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. 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. 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. For Far East Orchard, we've compiled three pertinent items you should assess:

  1. Risks: As an example, we've found 5 warning signs for Far East Orchard (1 is potentially serious!) that you need to consider before investing here.

  2. 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!

  3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. Simply Wall St updates its DCF calculation for every Singaporean 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.

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