A Look At The Intrinsic Value Of Grand Ocean Retail Group Ltd. (TWSE:5907)

Key Insights

• The projected fair value for Grand Ocean Retail Group is NT$11.45 based on 2 Stage Free Cash Flow to Equity
• With NT$9.30 share price, Grand Ocean Retail Group appears to be trading close to its estimated fair value
• Grand Ocean Retail Group's peers seem to be trading at a lower discount to fair value based onthe industry average of 18%

Today we will run through one way of estimating the intrinsic value of Grand Ocean Retail Group Ltd. (TWSE:5907) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Grand Ocean Retail Group

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. To begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (NT$, Millions)	NT$340.7m	NT$283.0m	NT$250.3m	NT$230.8m	NT$218.9m	NT$211.7m	NT$207.5m	NT$205.2m	NT$204.3m	NT$204.3m
Growth Rate Estimate Source	Est @ -24.63%	Est @ -16.94%	Est @ -11.55%	Est @ -7.78%	Est @ -5.14%	Est @ -3.29%	Est @ -2.00%	Est @ -1.09%	Est @ -0.46%	Est @ -0.02%
Present Value (NT$, Millions) Discounted @ 11%	NT$308	NT$231	NT$184	NT$154	NT$132	NT$115	NT$102	NT$90.9	NT$81.7	NT$73.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$1.5b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.0%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = NT$204m× (1 + 1.0%) ÷ (11%– 1.0%) = NT$2.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NT$2.1b÷ ( 1 + 11%)¹⁰= NT$768m

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$2.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NT$9.3, the company appears about fair value at a 19% discount to where the stock price trades currently. 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.

The 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 Grand Ocean Retail Group 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 2.000. 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.

Looking Ahead:

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 Grand Ocean Retail Group, we've put together three essential aspects you should explore:

1. Risks: We feel that you should assess the 3 warning signs for Grand Ocean Retail Group (2 make us uncomfortable!) we've flagged before making an investment in the company.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TWSE 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.