Is Hanwha Engine Co., Ltd. (KRX:082740) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

• Hanwha Engine's estimated fair value is ₩10,988 based on 2 Stage Free Cash Flow to Equity
• Hanwha Engine's ₩14,040 share price signals that it might be 28% overvalued
• The ₩15,850 analyst price target for A082740 is 44% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Hanwha Engine Co., Ltd. (KRX:082740) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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 Hanwha Engine

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (₩, Millions)	₩37.2b	₩78.4b	₩66.7b	₩60.3b	₩56.7b	₩54.7b	₩53.8b	₩53.6b	₩53.9b	₩54.5b
Growth Rate Estimate Source	Analyst x3	Analyst x2	Est @ -14.90%	Est @ -9.67%	Est @ -6.00%	Est @ -3.43%	Est @ -1.63%	Est @ -0.38%	Est @ 0.51%	Est @ 1.12%
Present Value (₩, Millions) Discounted @ 7.6%	₩34.5k	₩67.7k	₩53.5k	₩44.9k	₩39.2k	₩35.2k	₩32.1k	₩29.7k	₩27.8k	₩26.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩391b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.6%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₩55b× (1 + 2.6%) ÷ (7.6%– 2.6%) = ₩1.1t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩1.1t÷ ( 1 + 7.6%)¹⁰= ₩526b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩917b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₩14k, the company appears slightly overvalued 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.

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 Hanwha Engine 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 7.6%, which is based on a levered beta of 1.078. 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 Engine

Looking Ahead:

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. 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. What is the reason for the share price exceeding the intrinsic value? For Hanwha Engine, we've put together three fundamental elements you should explore:

1. Risks: For instance, we've identified 4 warning signs for Hanwha Engine (1 makes us a bit uncomfortable) you should be aware of.
2. Future Earnings: How does A082740'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.

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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.