Are Investors Undervaluing KHVATEC Co.,Ltd. (KOSDAQ:060720) By 30%?

Key Insights

• The projected fair value for KHVATECLtd is ₩15,948 based on 2 Stage Free Cash Flow to Equity
• KHVATECLtd's ₩11,230 share price signals that it might be 30% undervalued
• The average premium for KHVATECLtd's competitorsis currently 853%

How far off is KHVATEC Co.,Ltd. (KOSDAQ:060720) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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What's The Estimated Valuation?

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (₩, Millions)	₩27.0b	₩25.6b	₩24.9b	₩24.7b	₩24.8b	₩25.1b	₩25.5b	₩26.0b	₩26.6b	₩27.3b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -2.54%	Est @ -0.89%	Est @ 0.27%	Est @ 1.08%	Est @ 1.65%	Est @ 2.04%	Est @ 2.32%	Est @ 2.52%
Present Value (₩, Millions) Discounted @ 9.2%	₩24.7k	₩21.5k	₩19.2k	₩17.4k	₩16.0k	₩14.8k	₩13.8k	₩12.9k	₩12.1k	₩11.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩164b

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 3.0%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = ₩27b× (1 + 3.0%) ÷ (9.2%– 3.0%) = ₩452b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩452b÷ ( 1 + 9.2%)¹⁰= ₩188b

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 ₩351b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₩11k, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. 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.

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 KHVATECLtd 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 1.257. 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.

View our latest analysis for KHVATECLtd

SWOT Analysis for KHVATECLtd

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Why is the intrinsic value higher than the current share price? For KHVATECLtd, there are three additional factors you should look at:

1. Risks: You should be aware of the 2 warning signs for KHVATECLtd (1 is a bit unpleasant!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does A060720'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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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.