Stock Analysis

Is There An Opportunity With New Hope Corporation Limited's (ASX:NHC) 41% Undervaluation?

ASX:NHC
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, New Hope fair value estimate is AU$8.30
  • Current share price of AU$4.93 suggests New Hope is potentially 41% undervalued
  • Analyst price target for NHC is AU$5.15 which is 38% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of New Hope Corporation Limited (ASX:NHC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

View our latest analysis for New Hope

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.

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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (A$, Millions) AU$373.8m AU$538.7m AU$918.0m AU$619.0m AU$468.7m AU$392.4m AU$350.6m AU$326.9m AU$313.9m AU$307.3m
Growth Rate Estimate Source Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ -24.28% Est @ -16.27% Est @ -10.67% Est @ -6.74% Est @ -4.00% Est @ -2.08%
Present Value (A$, Millions) Discounted @ 6.9% AU$350 AU$472 AU$752 AU$474 AU$336 AU$263 AU$220 AU$192 AU$172 AU$158

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$3.4b

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = AU$307m× (1 + 2.4%) ÷ (6.9%– 2.4%) = AU$7.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$7.0b÷ ( 1 + 6.9%)10= AU$3.6b

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$7.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$4.9, the company appears quite undervalued at a 41% 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
ASX:NHC Discounted Cash Flow August 2nd 2024

Important 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 New Hope 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 6.9%, which is based on a levered beta of 1.084. 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 New Hope

Strength
  • Currently debt free.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Earnings declined over the past year.
Opportunity
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Dividends are not covered by cash flow.
  • Annual earnings are forecast to decline for the next 4 years.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value higher than the current share price? For New Hope, we've compiled three important aspects you should further research:

  1. Risks: Take risks, for example - New Hope has 2 warning signs (and 1 which is concerning) we think you should know about.
  2. Future Earnings: How does NHC'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. 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.

Valuation is complex, but we're here to simplify it.

Discover if New Hope might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.