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Estimating The Intrinsic Value Of Nordic Group Limited (SGX:MR7)

Simply Wall St

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Nordic Group Limited (SGX:MR7) 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 Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Nordic Group

Is Nordic Group fairly valued?

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. To begin with, we have to get estimates of the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF (SGD, Millions) SGD8.9m SGD8.4m SGD8.2m SGD8.0m SGD8.0m SGD8.1m SGD8.2m SGD8.3m SGD8.4m SGD8.6m
Growth Rate Estimate Source Est @ -8.33% Est @ -5.14% Est @ -2.91% Est @ -1.35% Est @ -0.25% Est @ 0.52% Est @ 1.05% Est @ 1.43% Est @ 1.69% Est @ 1.87%
Present Value (SGD, Millions) Discounted @ 9.78% SGD8.1 SGD7.0 SGD6.2 SGD5.5 SGD5.0 SGD4.6 SGD4.2 SGD3.9 SGD3.6 SGD3.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF)= SGD51.6m

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 a country's GDP growth. In this case we have used the 10-year government bond rate (2.3%) 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 9.8%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = S$8.6m × (1 + 2.3%) ÷ (9.8% – 2.3%) = S$117m

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = SGDS$117m ÷ ( 1 + 9.8%)10 = SGD46.12m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is SGD97.67m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value estimate of SGD0.25. Compared to the current share price of SGD0.25, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

SGX:MR7 Intrinsic value, August 28th 2019

The 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 Nordic 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 9.8%, which is based on a levered beta of 1.254. 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.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Nordic Group, I've compiled three essential factors you should further research:

  1. Financial Health: Does MR7 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.
  2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MR7? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SGX every day. If you want to find the calculation for other stocks just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.