Hanwha Aerospace Co., Ltd.'s (KRX:012450) Intrinsic Value Is Potentially 66% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Hanwha Aerospace fair value estimate is ₩1,458,491
• Hanwha Aerospace's ₩878,000 share price signals that it might be 40% undervalued
• The ₩908,200 analyst price target for A012450 is 38% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Hanwha Aerospace Co., Ltd. (KRX:012450) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Our free stock report includes 2 warning signs investors should be aware of before investing in Hanwha Aerospace. Read for free now.

The Method

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

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (₩, Millions)	₩832.2b	₩2.00t	₩2.58t	₩3.02t	₩3.41t	₩3.74t	₩4.03t	₩4.28t	₩4.50t	₩4.69t
Growth Rate Estimate Source	Analyst x5	Analyst x8	Analyst x6	Est @ 17.13%	Est @ 12.80%	Est @ 9.78%	Est @ 7.66%	Est @ 6.18%	Est @ 5.14%	Est @ 4.41%
Present Value (₩, Millions) Discounted @ 7.7%	₩772.4k	₩1.72m	₩2.06m	₩2.24m	₩2.35m	₩2.39m	₩2.39m	₩2.35m	₩2.30m	₩2.23m

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩21t

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 (2.7%) 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 7.7%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₩4.7t× (1 + 2.7%) ÷ (7.7%– 2.7%) = ₩96t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩96t÷ ( 1 + 7.7%)¹⁰= ₩46t

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 ₩66t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₩878k, the company appears quite undervalued at a 40% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Hanwha Aerospace 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 7.7%, which is based on a levered beta of 1.007. 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.

See our latest analysis for Hanwha Aerospace

SWOT Analysis for Hanwha Aerospace

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. What is the reason for the share price sitting below the intrinsic value? For Hanwha Aerospace, we've compiled three fundamental factors you should explore:

1. Risks: You should be aware of the 2 warning signs for Hanwha Aerospace (1 shouldn't be ignored!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does A012450'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.