AEM Holdings Ltd (SGX:AWX) Shares Could Be 49% Below Their Intrinsic Value Estimate

By
Simply Wall St
Published
June 02, 2021
SGX:AWX
Source: Shutterstock

In this article we are going to estimate the intrinsic value of AEM Holdings Ltd (SGX:AWX) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 AEM Holdings

The calculation

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) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (SGD, Millions) S$51.3m S$114.2m S$116.3m S$118.3m S$120.4m S$122.6m S$124.8m S$127.1m S$129.4m S$131.8m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Est @ 1.73% Est @ 1.77% Est @ 1.8% Est @ 1.82% Est @ 1.84% Est @ 1.85% Est @ 1.85%
Present Value (SGD, Millions) Discounted @ 7.1% S$47.9 S$99.5 S$94.5 S$89.8 S$85.3 S$81.0 S$77.0 S$73.2 S$69.6 S$66.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S$783m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = S$132m× (1 + 1.9%) ÷ (7.1%– 1.9%) = S$2.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$2.5b÷ ( 1 + 7.1%)10= S$1.3b

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 S$2.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of S$3.7, the company appears quite good value at a 49% 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
SGX:AWX Discounted Cash Flow June 3rd 2021

Important 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 AEM Holdings 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 7.1%, which is based on a levered beta of 1.117. 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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For AEM Holdings, we've compiled three further elements you should look at:

  1. Risks: Be aware that AEM Holdings is showing 2 warning signs in our investment analysis , you should know about...
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AWX's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Singaporean stock every day, so if you want to find the intrinsic value of any other stock just search here.

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