Is HD Korea Shipbuilding & Offshore Engineering Co., Ltd. (KRX:009540) Trading At A 25% Discount?

Key Insights

• HD Korea Shipbuilding & Offshore Engineering's estimated fair value is ₩166,047 based on 2 Stage Free Cash Flow to Equity
• HD Korea Shipbuilding & Offshore Engineering is estimated to be 25% undervalued based on current share price of ₩123,800
• Analyst price target for A009540 is ₩141,400 which is 15% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of HD Korea Shipbuilding & Offshore Engineering Co., Ltd. (KRX:009540) as an investment opportunity 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for HD Korea Shipbuilding & Offshore Engineering

The Calculation

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 start off with, we need to estimate 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₩, Millions)	₩679.2b	₩1.17t	₩1.04t	₩959.5b	₩916.9b	₩895.1b	₩886.7b	₩887.2b	₩894.0b	₩905.3b
Growth Rate Estimate Source	Analyst x6	Analyst x6	Est @ -11.55%	Est @ -7.36%	Est @ -4.43%	Est @ -2.38%	Est @ -0.94%	Est @ 0.06%	Est @ 0.77%	Est @ 1.26%
Present Value (₩, Millions) Discounted @ 9.1%	₩622.6k	₩984.1k	₩797.9k	₩677.6k	₩593.6k	₩531.2k	₩482.4k	₩442.5k	₩408.8k	₩379.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩5.9t

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₩905b× (1 + 2.4%) ÷ (9.1%– 2.4%) = ₩14t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩14t÷ ( 1 + 9.1%)¹⁰= ₩5.8t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩12t. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₩124k, the company appears a touch undervalued at a 25% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 HD Korea Shipbuilding & Offshore Engineering 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 9.1%, which is based on a levered beta of 1.255. 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 HD Korea Shipbuilding & Offshore Engineering

Next Steps:

Although the valuation of a company is important, it 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For HD Korea Shipbuilding & Offshore Engineering, there are three essential factors you should further examine:

1. Financial Health: Does A009540 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does A009540'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 KOSE 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.