Stock Analysis

Estimating The Intrinsic Value Of KEPCO Engineering & Construction Company, Inc. (KRX:052690)

KOSE:A052690
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Key Insights

Today we will run through one way of estimating the intrinsic value of KEPCO Engineering & Construction Company, Inc. (KRX:052690) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

View our latest analysis for KEPCO Engineering & Construction Company

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. 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, 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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (₩, Millions) ₩59.5b ₩75.7b ₩87.9b ₩98.5b ₩107.6b ₩115.4b ₩122.2b ₩128.1b ₩133.4b ₩138.3b
Growth Rate Estimate Source Analyst x4 Analyst x3 Est @ 16.18% Est @ 12.10% Est @ 9.23% Est @ 7.23% Est @ 5.83% Est @ 4.85% Est @ 4.16% Est @ 3.68%
Present Value (₩, Millions) Discounted @ 7.3% ₩55.5k ₩65.8k ₩71.2k ₩74.5k ₩75.8k ₩75.8k ₩74.8k ₩73.1k ₩71.0k ₩68.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩706b

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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = ₩138b× (1 + 2.6%) ÷ (7.3%– 2.6%) = ₩3.0t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₩3.0t÷ ( 1 + 7.3%)10= ₩1.5t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩2.2t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₩64k, the company appears around fair value at the time of writing. 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.

dcf
KOSE:A052690 Discounted Cash Flow September 6th 2024

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 KEPCO Engineering & Construction Company 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 7.3%, which is based on a levered beta of 0.995. 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 KEPCO Engineering & Construction Company

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Dividend is low compared to the top 25% of dividend payers in the Construction market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual revenue is forecast to grow faster than the South Korean market.
Threat
  • Paying a dividend but company has no free cash flows.
  • Annual earnings are forecast to grow slower than the South Korean market.

Moving On:

Whilst important, the DCF calculation 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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For KEPCO Engineering & Construction Company, there are three additional factors you should explore:

  1. Financial Health: Does A052690 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 A052690'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.

Valuation is complex, but we're here to simplify it.

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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.