A Look At The Intrinsic Value Of SalfaCorp S.A. (SNSE:SALFACORP)

Does the February share price for SalfaCorp S.A. (SNSE:SALFACORP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 SalfaCorp

Crunching the numbers

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (CLP, Millions)	CL$42.0b	CL$40.7b	CL$40.7b	CL$41.7b	CL$43.4b	CL$45.7b	CL$48.4b	CL$51.6b	CL$55.2b	CL$59.2b
Growth Rate Estimate Source	Est @ -7.93%	Est @ -3.2%	Est @ 0.12%	Est @ 2.44%	Est @ 4.07%	Est @ 5.21%	Est @ 6%	Est @ 6.56%	Est @ 6.95%	Est @ 7.22%
Present Value (CLP, Millions) Discounted @ 20%	CL$35.1k	CL$28.3k	CL$23.7k	CL$20.3k	CL$17.6k	CL$15.4k	CL$13.7k	CL$12.2k	CL$10.9k	CL$9.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CL$187b

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 5-year average of the 10-year government bond yield (7.9%) 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 20%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = CL$59b× (1 + 7.9%) ÷ (20%– 7.9%) = CL$534b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CL$534b÷ ( 1 + 20%)¹⁰= CL$88b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CL$274b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CL$525, the company appears about fair value at a 14% 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 SalfaCorp 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 20%, which is based on a levered beta of 1.908. 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 ideally won't be the sole piece of analysis you scrutinize 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. 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 SalfaCorp, we've put together three further aspects you should consider:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with SalfaCorp (including 2 which are significant) .
2. 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!
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 Chilean stock every day, so if you want to find the intrinsic value of any other stock just search here.

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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. 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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