Calculating The Fair Value Of PIMS Inc. (KOSDAQ:347770)

Does the February share price for PIMS Inc. (KOSDAQ:347770) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for PIMS

Crunching the numbers

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₩, Millions)	₩9.05b	₩9.89b	₩10.6b	₩11.3b	₩11.9b	₩12.5b	₩13.1b	₩13.7b	₩14.3b	₩14.8b
Growth Rate Estimate Source	Est @ 11.6%	Est @ 9.22%	Est @ 7.56%	Est @ 6.4%	Est @ 5.58%	Est @ 5.01%	Est @ 4.61%	Est @ 4.33%	Est @ 4.14%	Est @ 4%
Present Value (₩, Millions) Discounted @ 11%	₩8.2k	₩8.1k	₩7.9k	₩7.6k	₩7.2k	₩6.8k	₩6.5k	₩6.1k	₩5.8k	₩5.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩69b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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) = ₩15b× (1 + 3.7%) ÷ (11%– 3.7%) = ₩222b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₩222b÷ ( 1 + 11%)¹⁰= ₩81b

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 ₩150b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₩17k, the company appears about fair value at a 16% 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.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 PIMS 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 1.164. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. For PIMS, we've put together three further items you should look at:

1. Risks: Case in point, we've spotted 1 warning sign for PIMS you should be aware of.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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. 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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