Stock Analysis

Calculating The Intrinsic Value Of Delta Asia International Corporation (GTSM:6762)

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TPEX:6762
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Does the March share price for Delta Asia International Corporation (GTSM:6762) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. 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 Delta Asia International

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (NT$, Millions) NT$218.7m NT$260.3m NT$295.6m NT$324.5m NT$347.4m NT$365.4m NT$379.6m NT$390.9m NT$400.0m NT$407.5m
Growth Rate Estimate Source Est @ 26.81% Est @ 19.02% Est @ 13.56% Est @ 9.74% Est @ 7.07% Est @ 5.2% Est @ 3.89% Est @ 2.97% Est @ 2.33% Est @ 1.88%
Present Value (NT$, Millions) Discounted @ 6.3% NT$206 NT$230 NT$246 NT$254 NT$255 NT$253 NT$247 NT$239 NT$230 NT$220

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$2.4b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.8%) 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 6.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NT$408m× (1 + 0.8%) ÷ (6.3%– 0.8%) = NT$7.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NT$7.5b÷ ( 1 + 6.3%)10= NT$4.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NT$6.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of NT$305, the company appears about fair value at a 1.5% 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
GTSM:6762 Discounted Cash Flow March 4th 2021

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 Delta Asia International 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 6.3%, which is based on a levered beta of 0.900. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Delta Asia International, we've compiled three essential elements you should look at:

  1. Risks: Case in point, we've spotted 2 warning signs for Delta Asia International you should be aware of.
  2. 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!
  3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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

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About TPEX:6762

Delta Asia International

Delta Asia International Corporation manufactures and sells medical device parts and final products in Taiwan.

Flawless balance sheet with questionable track record.

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