How far off is SKY Network Television Limited (NZSE:SKT) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. Our analysis will employ 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
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.
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) forecast
|Levered FCF (NZ$, Millions)||NZ$81.0m||NZ$54.0m||NZ$29.0m||NZ$30.0m||NZ$35.0m||NZ$31.6m||NZ$29.6m||NZ$28.6m||NZ$28.1m||NZ$28.0m|
|Growth Rate Estimate Source||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Est @ -9.81%||Est @ -6.09%||Est @ -3.48%||Est @ -1.66%||Est @ -0.38%|
|Present Value (NZ$, Millions) Discounted @ 9.2%||NZ$74.2||NZ$45.3||NZ$22.3||NZ$21.1||NZ$22.5||NZ$18.6||NZ$16.0||NZ$14.1||NZ$12.7||NZ$11.6|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$258m
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 (2.6%) 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 9.2%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NZ$28m× (1 + 2.6%) ÷ (9.2%– 2.6%) = NZ$435m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$435m÷ ( 1 + 9.2%)10= NZ$180m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$438m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of NZ$0.1, the company appears quite good value at a 41% 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.
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 SKY Network Television 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 1.101. 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.
Whilst important, the DCF calculation shouldn’t be the only metric you look at when researching 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. What is the reason for the share price sitting below the intrinsic value? For SKY Network Television, there are three relevant items you should explore:
- Risks: Take risks, for example – SKY Network Television has 1 warning sign we think you should be aware of.
- Future Earnings: How does SKT’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.
- 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 NZSE 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. 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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