Nemak, S. A. B. de C. V. (BMV:NEMAKA) Shares Could Be 48% Below Their Intrinsic Value Estimate

How far off is Nemak, S. A. B. de C. V. (BMV:NEMAKA) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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

The calculation

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 begin with, we have to get estimates of 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.

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) estimate

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (MX$, Millions)	Mex$1.71b	Mex$2.47b	Mex$3.09b	Mex$3.71b	Mex$4.30b	Mex$4.88b	Mex$5.44b	Mex$6.00b	Mex$6.55b	Mex$7.11b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 25.4%	Est @ 19.91%	Est @ 16.07%	Est @ 13.38%	Est @ 11.49%	Est @ 10.18%	Est @ 9.25%	Est @ 8.61%
Present Value (MX$, Millions) Discounted @ 19%	Mex$1.4k	Mex$1.8k	Mex$1.9k	Mex$1.9k	Mex$1.8k	Mex$1.8k	Mex$1.7k	Mex$1.5k	Mex$1.4k	Mex$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = Mex$16b

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 (7.1%) 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 19%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = Mex$7.1b× (1 + 7.1%) ÷ (19%– 7.1%) = Mex$67b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= Mex$67b÷ ( 1 + 19%)¹⁰= Mex$12b

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 Mex$29b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of Mex$4.8, the company appears quite good value at a 48% 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.

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 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 19%, 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.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. Why is the intrinsic value higher than the current share price? For Nemak S. A. B. de C. V, there are three important elements you should further research:

1. Risks: Case in point, we've spotted 4 warning signs for Nemak S. A. B. de C. V you should be aware of, and 1 of them is a bit unpleasant.
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.

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.

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