Stock Analysis

Are Investors Undervaluing Chorus Limited (NZSE:CNU) By 47%?

NZSE:CNU
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Chorus fair value estimate is NZ$14.69
  • Chorus' NZ$7.78 share price signals that it might be 47% undervalued
  • Our fair value estimate is 48% lower than Chorus' analyst price target of NZ$7.63

In this article we are going to estimate the intrinsic value of Chorus Limited (NZSE:CNU) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

View our latest analysis for Chorus

The Model

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (NZ$, Millions) NZ$96.0m NZ$213.5m NZ$282.5m NZ$305.0m NZ$331.0m NZ$350.6m NZ$367.4m NZ$382.1m NZ$395.3m NZ$407.5m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x2 Analyst x2 Est @ 5.92% Est @ 4.79% Est @ 4.01% Est @ 3.46% Est @ 3.07%
Present Value (NZ$, Millions) Discounted @ 7.0% NZ$89.7 NZ$187 NZ$231 NZ$233 NZ$236 NZ$234 NZ$229 NZ$223 NZ$215 NZ$208

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$2.1b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = NZ$407m× (1 + 2.2%) ÷ (7.0%– 2.2%) = NZ$8.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$8.7b÷ ( 1 + 7.0%)10= NZ$4.4b

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$6.5b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$7.8, the company appears quite undervalued at a 47% 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.

dcf
NZSE:CNU Discounted Cash Flow March 15th 2023

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Chorus 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 7.0%, which is based on a levered beta of 0.810. 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 Chorus

Strength
  • No major strengths identified for CNU.
Weakness
  • Earnings declined over the past year.
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Telecom market.
Opportunity
  • Annual earnings are forecast to grow faster than the New Zealander market.
  • Trading below our estimate of fair value by more than 20%.
  • Significant insider buying over the past 3 months.
Threat
  • Debt is not well covered by operating cash flow.
  • Dividends are not covered by earnings and cashflows.
  • Annual revenue is forecast to grow slower than the New Zealander market.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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. Why is the intrinsic value higher than the current share price? For Chorus, there are three additional items you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Chorus (at least 2 which are a bit concerning) , and understanding these should be part of your investment process.
  2. Future Earnings: How does CNU'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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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.