Hanwha Ocean Co., Ltd. (KRX:042660) Shares Could Be 36% Below Their Intrinsic Value Estimate

Key Insights

• Hanwha Ocean's estimated fair value is ₩47,566 based on 2 Stage Free Cash Flow to Equity
• Hanwha Ocean's ₩30,300 share price signals that it might be 36% undervalued
• The ₩33,540 analyst price target for A042660 is 29% less than our estimate of fair value

Does the June share price for Hanwha Ocean Co., Ltd. (KRX:042660) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for Hanwha Ocean

What's The Estimated Valuation?

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

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (₩, Millions)	-₩366.3b	₩333.4b	₩540.0b	₩708.6b	₩868.8b	₩1.01t	₩1.14t	₩1.24t	₩1.34t	₩1.41t
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x2	Est @ 31.23%	Est @ 22.60%	Est @ 16.57%	Est @ 12.34%	Est @ 9.38%	Est @ 7.31%	Est @ 5.86%
Present Value (₩, Millions) Discounted @ 8.7%	-₩336.8k	₩281.9k	₩420.0k	₩506.8k	₩571.4k	₩612.5k	₩632.8k	₩636.5k	₩628.1k	₩611.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩4.6t

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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = ₩1.4t× (1 + 2.5%) ÷ (8.7%– 2.5%) = ₩23t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩23t÷ ( 1 + 8.7%)¹⁰= ₩10t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩15t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₩30k, the company appears quite good value at a 36% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 Ocean 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 8.7%, which is based on a levered beta of 1.177. 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 Hanwha Ocean

Moving On:

Although the valuation of a company is important, it 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. 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 Hanwha Ocean, we've put together three relevant factors you should assess:

1. Risks: For instance, we've identified 3 warning signs for Hanwha Ocean (1 is a bit unpleasant) you should be aware of.
2. Future Earnings: How does A042660'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 South Korean stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com