Are Investors Undervaluing Nemak, S. A. B. de C. V. (BMV:NEMAKA) By 22%?

Key Insights

• Nemak S. A. B. de C. V's estimated fair value is Mex$7.7 based on 2 Stage Free Cash Flow to Equity
• Current share price of Mex$6.0 suggests Nemak S. A. B. de C. V is 22% undervalued
• Analyst price target for NEMAK A is Mex$7.75 which is 0.6% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Nemak, S. A. B. de C. V. (BMV:NEMAKA) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Nemak S. A. B. de C. V

Crunching The Numbers

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. 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, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MX$, Millions)	-Mex$497.5m	Mex$363.6m	Mex$1.76b	Mex$2.49b	Mex$4.61b	Mex$6.48b	Mex$8.47b	Mex$10.5b	Mex$12.4b	Mex$14.3b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x1	Analyst x1	Est @ 40.61%	Est @ 30.63%	Est @ 23.64%	Est @ 18.75%	Est @ 15.33%
Present Value (MX$, Millions) Discounted @ 24%	-Mex$402	Mex$237	Mex$929	Mex$1.1k	Mex$1.6k	Mex$1.8k	Mex$1.9k	Mex$1.9k	Mex$1.8k	Mex$1.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Mex$13b

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. 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 7.3%. We discount the terminal cash flows to today's value at a cost of equity of 24%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = Mex$14b× (1 + 7.3%) ÷ (24%– 7.3%) = Mex$93b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Mex$93b÷ ( 1 + 24%)¹⁰= Mex$11b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is Mex$24b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of Mex$6.0, the company appears a touch undervalued at a 22% 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

Now 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 Nemak S. A. B. de C. V 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 24%, which is based on a levered beta of 2.000. 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 Nemak S. A. B. de C. V

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Nemak S. A. B. de C. V, we've put together three fundamental factors you should further research:

1. Risks: Every company has them, and we've spotted 2 warning signs for Nemak S. A. B. de C. V you should know about.
2. Future Earnings: How does NEMAK A'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 BMV 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. 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.