Is There An Opportunity With Nemak, S. A. B. de C. V.'s (BMV:NEMAKA) 31% Undervaluation?

Key Insights

• Nemak S. A. B. de C. V's estimated fair value is Mex$4.72 based on 2 Stage Free Cash Flow to Equity
• Nemak S. A. B. de C. V is estimated to be 31% undervalued based on current share price of Mex$3.27
• The US$6.82 analyst price target for NEMAK A is 45% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Nemak, S. A. B. de C. V. (BMV:NEMAKA) 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. It may sound complicated, but actually it is quite simple!

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 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.

Check out our latest analysis for Nemak S. A. B. de C. V

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. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$112.2m	US$113.8m	US$96.8m	US$169.0m	US$184.9m	US$199.9m	US$215.8m	US$232.9m	US$251.1m	US$270.7m
Growth Rate Estimate Source	Analyst x1	Analyst x4	Analyst x2	Analyst x1	Analyst x1	Est @ 8.09%	Est @ 7.98%	Est @ 7.90%	Est @ 7.84%	Est @ 7.80%
Present Value ($, Millions) Discounted @ 22%	US$91.6	US$75.9	US$52.7	US$75.1	US$67.1	US$59.2	US$52.2	US$46.0	US$40.5	US$35.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$596m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (7.7%) 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 22%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$271m× (1 + 7.7%) ÷ (22%– 7.7%) = US$2.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.0b÷ ( 1 + 22%)¹⁰= US$260m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$856m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of Mex$3.3, the company appears quite good value at a 31% 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

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 22%, 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

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. 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 discount to intrinsic value? For Nemak S. A. B. de C. V, we've compiled three pertinent aspects you should look at:

1. Risks: Be aware that Nemak S. A. B. de C. V is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...
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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.