Aguas Andinas S.A.'s (SNSE:AGUAS-A) Intrinsic Value Is Potentially 62% Above Its Share Price

Key Insights

• Aguas Andinas' estimated fair value is CL$300 based on 2 Stage Free Cash Flow to Equity
• Current share price of CL$185 suggests Aguas Andinas is 38% undervalued
• Analyst price target for AGUAS-A is CL$268 which is 11% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Aguas Andinas S.A. (SNSE:AGUAS-A) by estimating the company's future cash flows and discounting them to their present 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!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Aguas Andinas

Crunching The Numbers

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.

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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CLP, Millions)	CL$123.0b	CL$129.0b	CL$136.0b	CL$144.4b	CL$154.0b	CL$164.9b	CL$176.9b	CL$190.2b	CL$204.6b	CL$220.3b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 5.43%	Est @ 6.17%	Est @ 6.68%	Est @ 7.05%	Est @ 7.30%	Est @ 7.48%	Est @ 7.60%	Est @ 7.69%
Present Value (CLP, Millions) Discounted @ 14%	CL$107.8k	CL$99.2k	CL$91.7k	CL$85.3k	CL$79.8k	CL$74.9k	CL$70.5k	CL$66.4k	CL$62.7k	CL$59.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CL$798b

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 7.9%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CL$220b× (1 + 7.9%) ÷ (14%– 7.9%) = CL$3.9t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CL$3.9t÷ ( 1 + 14%)¹⁰= CL$1.0t

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$1.8t. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CL$185, the company appears quite good value at a 38% 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 Aguas Andinas 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 14%, which is based on a levered beta of 0.880. 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 Aguas Andinas

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Aguas Andinas, we've compiled three essential aspects you should further examine:

1. Risks: Take risks, for example - Aguas Andinas has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.
2. Future Earnings: How does AGUAS-A'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 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!

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. 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.