Stock Analysis

A Look At The Fair Value Of Standard Chem & Pharm CO., LTD. (TPE:1720)

TWSE:1720
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Today we will run through one way of estimating the intrinsic value of Standard Chem & Pharm CO., LTD. (TPE:1720) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for Standard Chem & Pharm

The method

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, 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$388.0m NT$379.6m NT$374.8m NT$372.6m NT$372.2m NT$372.9m NT$374.4m NT$376.6m NT$379.2m NT$382.0m
Growth Rate Estimate Source Analyst x1 Est @ -2.18% Est @ -1.24% Est @ -0.59% Est @ -0.13% Est @ 0.19% Est @ 0.42% Est @ 0.57% Est @ 0.68% Est @ 0.76%
Present Value (NT$, Millions) Discounted @ 6.7% NT$364 NT$334 NT$309 NT$288 NT$270 NT$253 NT$238 NT$225 NT$212 NT$200

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$2.7b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (0.9%) 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 6.7%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NT$382m× (1 + 0.9%) ÷ (6.7%– 0.9%) = NT$6.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NT$6.7b÷ ( 1 + 6.7%)10= NT$3.5b

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$6.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of NT$38.6, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
TSEC:1720 Discounted Cash Flow December 9th 2020

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. 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 Standard Chem & Pharm 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 6.7%, which is based on a levered beta of 0.804. 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 shouldn't be the only metric you look at when researching 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. For Standard Chem & Pharm, we've put together three fundamental factors you should consider:

  1. Risks: For example, we've discovered 1 warning sign for Standard Chem & Pharm that you should be aware of before investing here.
  2. Future Earnings: How does 1720'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. 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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