Estimating The Fair Value Of Kinatico Ltd (ASX:KYP)

Key Insights

• The projected fair value for Kinatico is AU$0.07 based on 2 Stage Free Cash Flow to Equity
• With AU$0.07 share price, Kinatico appears to be trading close to its estimated fair value
• Our fair value estimate is 36% lower than Kinatico's analyst price target of AU$0.11

Today we will run through one way of estimating the intrinsic value of Kinatico Ltd (ASX:KYP) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Kinatico

What's The Estimated Valuation?

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

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (A$, Millions)	-AU$600.0k	AU$1.40m	AU$1.70m	AU$1.92m	AU$2.11m	AU$2.26m	AU$2.39m	AU$2.50m	AU$2.60m	AU$2.68m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ 13.05%	Est @ 9.71%	Est @ 7.38%	Est @ 5.74%	Est @ 4.60%	Est @ 3.80%	Est @ 3.24%
Present Value (A$, Millions) Discounted @ 8.4%	-AU$0.6	AU$1.2	AU$1.3	AU$1.4	AU$1.4	AU$1.4	AU$1.4	AU$1.3	AU$1.3	AU$1.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$11m

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 8.4%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = AU$2.7m× (1 + 1.9%) ÷ (8.4%– 1.9%) = AU$42m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$42m÷ ( 1 + 8.4%)¹⁰= AU$19m

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 AU$30m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.07, the company appears about fair value at a 0.3% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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 Kinatico 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 8.4%, 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Kinatico, there are three relevant aspects you should consider:

1. Risks: We feel that you should assess the 1 warning sign for Kinatico we've flagged before making an investment in the company.
2. Future Earnings: How does KYP'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.

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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.