Stock Analysis

Is There An Opportunity With CUCKOO Homesys Co., Ltd's (KRX:284740) 40% Undervaluation?

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KOSE:A284740
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Does the March share price for CUCKOO Homesys Co., Ltd (KRX:284740) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for CUCKOO Homesys

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (₩, Millions) ₩72.6b ₩89.6b ₩102.7b ₩114.4b ₩124.7b ₩134.0b ₩142.4b ₩150.3b ₩157.7b ₩164.9b
Growth Rate Estimate Source Analyst x3 Analyst x3 Est @ 14.61% Est @ 11.33% Est @ 9.03% Est @ 7.43% Est @ 6.3% Est @ 5.52% Est @ 4.97% Est @ 4.58%
Present Value (₩, Millions) Discounted @ 11% ₩65.5k ₩73.0k ₩75.5k ₩75.8k ₩74.6k ₩72.3k ₩69.4k ₩66.1k ₩62.6k ₩59.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩694b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (3.7%) 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 11%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₩165b× (1 + 3.7%) ÷ (11%– 3.7%) = ₩2.4t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₩2.4t÷ ( 1 + 11%)10= ₩857b

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 ₩1.6t. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₩42k, the company appears quite undervalued at a 40% 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.

dcf
KOSE:A284740 Discounted Cash Flow March 17th 2021

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 CUCKOO Homesys 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 11%, which is based on a levered beta of 1.198. 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.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 CUCKOO Homesys, we've compiled three essential aspects you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with CUCKOO Homesys , and understanding it should be part of your investment process.
  2. Future Earnings: How does A284740'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. 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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About KOSE:A284740

CUCKOO Homesys

Cuckoo Homesys Co., Ltd. engages in the manufacture, sale, and rental of household appliances.

Excellent balance sheet second-rate dividend payer.

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