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Kaiser Aluminum Corporation's (NASDAQ:KALU) Intrinsic Value Is Potentially 17% Below Its Share Price

Key Insights

  • The projected fair value for Kaiser Aluminum is US$45.00 based on 2 Stage Free Cash Flow to Equity

  • Kaiser Aluminum's US$54.28 share price signals that it might be 21% overvalued

  • Kaiser Aluminum's peers seem to be trading at a higher premium to fair value based onthe industry average of -192%

In this article we are going to estimate the intrinsic value of Kaiser Aluminum Corporation (NASDAQ:KALU) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Kaiser Aluminum

The Model

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$52.0m

US$57.6m

US$62.3m

US$66.2m

US$69.6m

US$72.6m

US$75.2m

US$77.5m

US$79.8m

US$81.9m

Growth Rate Estimate Source

Analyst x1

Est @ 10.74%

Est @ 8.16%

Est @ 6.36%

Est @ 5.10%

Est @ 4.21%

Est @ 3.59%

Est @ 3.16%

Est @ 2.86%

Est @ 2.65%

Present Value ($, Millions) Discounted @ 11%

US$46.8

US$46.6

US$45.4

US$43.4

US$41.1

US$38.5

US$35.9

US$33.4

US$30.9

US$28.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$391m

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$82m× (1 + 2.2%) ÷ (11%– 2.2%) = US$932m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$932m÷ ( 1 + 11%)10= US$325m

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 US$715m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$54.3, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Kaiser Aluminum 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 1.794. 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 Kaiser Aluminum

Strength

  • 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 faster than the American market.

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by earnings.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a premium to intrinsic value? For Kaiser Aluminum, we've compiled three fundamental elements you should look at:

  1. Risks: Take risks, for example - Kaiser Aluminum has 4 warning signs (and 2 which are a bit unpleasant) we think you should know about.

  2. Future Earnings: How does KALU'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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