A Look At The Intrinsic Value Of KMD Brands Limited (NZSE:KMD)

Key Insights

• The projected fair value for KMD Brands is NZ$0.51 based on 2 Stage Free Cash Flow to Equity
• KMD Brands' NZ$0.47 share price indicates it is trading at similar levels as its fair value estimate
• The NZ$0.68 analyst price target for KMD is 32% more than our estimate of fair value

How far off is KMD Brands Limited (NZSE:KMD) 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. 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 KMD Brands

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NZ$, Millions)	NZ$34.1m	NZ$59.6m	NZ$44.2m	NZ$36.1m	NZ$31.8m	NZ$29.4m	NZ$28.1m	NZ$27.4m	NZ$27.2m	NZ$27.2m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ -18.27%	Est @ -11.99%	Est @ -7.59%	Est @ -4.51%	Est @ -2.36%	Est @ -0.85%	Est @ 0.21%
Present Value (NZ$, Millions) Discounted @ 10%	NZ$30.9	NZ$49.1	NZ$33.1	NZ$24.6	NZ$19.6	NZ$16.5	NZ$14.3	NZ$12.7	NZ$11.4	NZ$10.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$223m

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 (2.7%) 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 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$27m× (1 + 2.7%) ÷ (10%– 2.7%) = NZ$375m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$375m÷ ( 1 + 10%)¹⁰= NZ$143m

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$365m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$0.5, the company appears about fair value at a 7.5% 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 KMD Brands 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 10%, which is based on a levered beta of 1.621. 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 KMD Brands

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. DCF models are not the be-all and end-all of investment valuation. 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. For KMD Brands, we've put together three fundamental elements you should further examine:

1. Risks: Be aware that KMD Brands is showing 2 warning signs in our investment analysis , you should know about...
2. Future Earnings: How does KMD'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 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. 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.