Amorepacific Corporation (KRX:090430) Shares Could Be 30% Above Their Intrinsic Value Estimate

Today we will run through one way of estimating the intrinsic value of Amorepacific Corporation (KRX:090430) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Amorepacific

The model

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

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₩, Millions)	₩429.0b	₩472.6b	₩580.5b	₩649.3b	₩710.3b	₩764.8b	₩814.4b	₩860.3b	₩903.8b	₩945.7b
Growth Rate Estimate Source	Analyst x11	Analyst x10	Analyst x2	Est @ 11.84%	Est @ 9.4%	Est @ 7.68%	Est @ 6.48%	Est @ 5.64%	Est @ 5.05%	Est @ 4.64%
Present Value (₩, Millions) Discounted @ 9.2%	₩393.0k	₩396.6k	₩446.4k	₩457.4k	₩458.4k	₩452.2k	₩441.1k	₩426.9k	₩410.9k	₩393.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩4.3t

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 3.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₩946b× (1 + 3.7%) ÷ (9.2%– 3.7%) = ₩18t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩18t÷ ( 1 + 9.2%)¹⁰= ₩7.5t

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 ₩12t. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₩223k, the company appears potentially overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The 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. 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 Amorepacific 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 9.2%, which is based on a levered beta of 0.918. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For Amorepacific, we've compiled three fundamental items you should consider:

1. Risks: Be aware that Amorepacific is showing 3 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does A090430'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. 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.
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