Stock Analysis

AEM Holdings Ltd.'s (SGX:AWX) Intrinsic Value Is Potentially 35% Above Its Share Price

SGX:AWX
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Key Insights

  • AEM Holdings' estimated fair value is S$4.85 based on 2 Stage Free Cash Flow to Equity
  • AEM Holdings is estimated to be 26% undervalued based on current share price of S$3.60
  • Analyst price target for AWX is S$3.54 which is 27% below our fair value estimate

How far off is AEM Holdings Ltd. (SGX:AWX) 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 today's 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.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for AEM Holdings

Step By Step Through The Calculation

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.

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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (SGD, Millions) S$255.3m S$140.3m S$130.6m S$125.4m S$122.6m S$121.4m S$121.2m S$121.8m S$123.0m S$124.5m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Est @ -4.01% Est @ -2.23% Est @ -0.98% Est @ -0.11% Est @ 0.50% Est @ 0.93% Est @ 1.23%
Present Value (SGD, Millions) Discounted @ 10% S$232 S$116 S$98.1 S$85.6 S$76.1 S$68.4 S$62.2 S$56.8 S$52.1 S$47.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S$895m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = S$124m× (1 + 1.9%) ÷ (10%– 1.9%) = S$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$1.6b÷ ( 1 + 10%)10= S$604m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is S$1.5b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of S$3.6, the company appears a touch undervalued at a 26% 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.

dcf
SGX:AWX Discounted Cash Flow May 2nd 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 10%, which is based on a levered beta of 1.361. 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 AEM Holdings

Strength
  • Earnings growth over the past year exceeded its 5-year average.
  • Debt is well covered by earnings.
Weakness
  • Earnings growth over the past year underperformed the Semiconductor industry.
  • Dividend is low compared to the top 25% of dividend payers in the Semiconductor market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Paying a dividend but company has no free cash flows.
  • Annual earnings are forecast to grow slower than the Singaporean market.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. Why is the intrinsic value higher than the current share price? For AEM Holdings, we've put together three fundamental aspects you should look at:

  1. Risks: Case in point, we've spotted 2 warning signs for AEM Holdings you should be aware of, and 1 of them makes us a bit uncomfortable.
  2. Future Earnings: How does AWX'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 SGX every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether AEM Holdings is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.