Stock Analysis

Are Investors Undervaluing GS Engineering & Construction Corporation (KRX:006360) By 36%?

KOSE:A006360
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How far off is GS Engineering & Construction Corporation (KRX:006360) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for GS Engineering & Construction

The calculation

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (₩, Millions) ₩404.0b ₩609.0b ₩594.3b ₩591.6b ₩596.2b ₩606.1b ₩619.8b ₩636.4b ₩655.4b ₩676.3b
Growth Rate Estimate Source Analyst x3 Analyst x12 Analyst x7 Est @ -0.46% Est @ 0.78% Est @ 1.65% Est @ 2.26% Est @ 2.69% Est @ 2.98% Est @ 3.19%
Present Value (₩, Millions) Discounted @ 12% ₩360.0k ₩483.6k ₩420.6k ₩373.1k ₩335.1k ₩303.5k ₩276.6k ₩253.1k ₩232.3k ₩213.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩3.3t

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 (3.7%) 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 12%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₩676b× (1 + 3.7%) ÷ (12%– 3.7%) = ₩8.2t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₩8.2t÷ ( 1 + 12%)10= ₩2.6t

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 ₩5.8t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₩44k, the company appears quite good value at a 36% 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.

dcf
KOSE:A006360 Discounted Cash Flow April 30th 2021

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 GS Engineering & Construction 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 12%, which is based on a levered beta of 1.432. 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.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For GS Engineering & Construction, there are three further items you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with GS Engineering & Construction (at least 1 which is significant) , and understanding these should be part of your investment process.
  2. Future Earnings: How does A006360'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. Simply Wall St updates its DCF calculation for every South Korean stock every day, so if you want to find the intrinsic value of any other stock just search here.

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