Estimating The Intrinsic Value Of Empresas Lipigas S.A. (SNSE:LIPIGAS)

Today we will run through one way of estimating the intrinsic value of Empresas Lipigas S.A. (SNSE:LIPIGAS) 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. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Empresas Lipigas

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 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (CLP, Millions)	CL$35.3b	CL$34.7b	CL$35.1b	CL$36.2b	CL$37.8b	CL$39.9b	CL$42.3b	CL$45.0b	CL$48.1b	CL$51.4b
Growth Rate Estimate Source	Est @ -5.44%	Est @ -1.55%	Est @ 1.18%	Est @ 3.09%	Est @ 4.42%	Est @ 5.36%	Est @ 6.01%	Est @ 6.47%	Est @ 6.79%	Est @ 7.02%
Present Value (CLP, Millions) Discounted @ 17%	CL$30.2k	CL$25.5k	CL$22.0k	CL$19.5k	CL$17.4k	CL$15.7k	CL$14.2k	CL$13.0k	CL$11.9k	CL$10.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CL$180b

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 (7.5%) 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 17%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = CL$51b× (1 + 7.5%) ÷ (17%– 7.5%) = CL$596b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CL$596b÷ ( 1 + 17%)¹⁰= CL$126b

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$306b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CL$2.4k, the company appears about fair value at a 10% discount to where the stock price trades currently. 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.

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Empresas Lipigas 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 17%, which is based on a levered beta of 1.868. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For Empresas Lipigas, there are three further aspects you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Empresas Lipigas (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

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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