Is There An Opportunity With Loma Negra Compañía Industrial Argentina Sociedad Anónima's (NYSE:LOMA) 46% Undervaluation?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Loma Negra Compañía Industrial Argentina Sociedad Anónima (NYSE:LOMA) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Loma Negra Compañía Industrial Argentina Sociedad Anónima

Is Loma Negra Compañía Industrial Argentina Sociedad Anónima fairly valued?

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (ARS, Millions)	AR$7.44b	AR$14.2b	AR$14.4b	AR$17.6b	AR$22.0b	AR$24.5b	AR$26.6b	AR$28.3b	AR$29.8b	AR$31.1b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Est @ 11.42%	Est @ 8.61%	Est @ 6.64%	Est @ 5.26%	Est @ 4.29%
Present Value (ARS, Millions) Discounted @ 21%	AR$6.2k	AR$9.8k	AR$8.2k	AR$8.3k	AR$8.6k	AR$7.9k	AR$7.1k	AR$6.3k	AR$5.5k	AR$4.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AR$72b

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 (2.0%) 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 21%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = AR$31b× (1 + 2.0%) ÷ (21%– 2.0%) = AR$170b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AR$170b÷ ( 1 + 21%)¹⁰= AR$26b

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 AR$98b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$5.2, the company appears quite good value at a 46% 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.

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 Loma Negra Compañía Industrial Argentina Sociedad Anónima 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 21%, which is based on a levered beta of 0.817. 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.

Next Steps:

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. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Loma Negra Compañía Industrial Argentina Sociedad Anónima, there are three essential items you should further examine:

1. Risks: Take risks, for example - Loma Negra Compañía Industrial Argentina Sociedad Anónima has 1 warning sign we think you should be aware of.
2. Future Earnings: How does LOMA'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 NYSE 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. 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.
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