Estimating The Intrinsic Value Of KGHM Polska Miedz S.A. (WSE:KGH)

Key Insights

• KGHM Polska Miedz's estimated fair value is zł127 based on 2 Stage Free Cash Flow to Equity
• KGHM Polska Miedz's zł119 share price indicates it is trading at similar levels as its fair value estimate
• The zł98.89 analyst price target for KGH is 22% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of KGHM Polska Miedz S.A. (WSE:KGH) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for KGHM Polska Miedz

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, 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (PLN, Millions)	-zł100.4m	zł393.5m	zł709.9m	zł1.12b	zł1.58b	zł2.05b	zł2.50b	zł2.91b	zł3.27b	zł3.59b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 80.40%	Est @ 57.32%	Est @ 41.17%	Est @ 29.86%	Est @ 21.94%	Est @ 16.40%	Est @ 12.52%	Est @ 9.81%
Present Value (PLN, Millions) Discounted @ 11%	-zł90.4	zł319	zł518	zł733	zł932	zł1.1k	zł1.2k	zł1.3k	zł1.3k	zł1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł8.5b

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. 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 3.5%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = zł3.6b× (1 + 3.5%) ÷ (11%– 3.5%) = zł49b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł49b÷ ( 1 + 11%)¹⁰= zł17b

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 zł25b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of zł119, the company appears about fair value at a 6.7% 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 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 KGHM Polska Miedz 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 11%, which is based on a levered beta of 1.214. 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 KGHM Polska Miedz

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. For KGHM Polska Miedz, there are three important items you should consider:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with KGHM Polska Miedz .
2. Future Earnings: How does KGH'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 WSE 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.