Calculating The Intrinsic Value Of LG Energy Solution, Ltd. (KRX:373220)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, LG Energy Solution fair value estimate is ₩373,390
• Current share price of ₩375,000 suggests LG Energy Solution is potentially trading close to its fair value
• Our fair value estimate is 17% lower than LG Energy Solution's analyst price target of ₩447,633

Does the July share price for LG Energy Solution, Ltd. (KRX:373220) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. 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 LG Energy Solution

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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)	-₩3.80t	₩1.11t	₩5.76t	₩6.23t	₩6.60t	₩6.91t	₩7.20t	₩7.46t	₩7.70t	₩7.94t
Growth Rate Estimate Source	Analyst x14	Analyst x12	Analyst x2	Analyst x2	Est @ 5.81%	Est @ 4.81%	Est @ 4.11%	Est @ 3.62%	Est @ 3.28%	Est @ 3.04%
Present Value (₩, Millions) Discounted @ 8.7%	-₩3.50m	₩937.3k	₩4.49m	₩4.47m	₩4.36m	₩4.20m	₩4.03m	₩3.84m	₩3.65m	₩3.46m

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩30t

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)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₩7.9t× (1 + 2.5%) ÷ (8.7%– 2.5%) = ₩132t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩132t÷ ( 1 + 8.7%)¹⁰= ₩57t

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩87t. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₩375k, the company appears around fair value at the time of writing. 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

We would point out that 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 LG Energy Solution 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 1.161. 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 LG Energy Solution

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For LG Energy Solution, we've compiled three important factors you should explore:

1. Risks: Be aware that LG Energy Solution is showing 2 warning signs in our investment analysis , and 1 of those is significant...
2. Future Earnings: How does A373220'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. 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.

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