An Intrinsic Calculation For Northam Platinum Holdings Limited (JSE:NPH) Suggests It's 47% Undervalued

In this article we are going to estimate the intrinsic value of Northam Platinum Holdings Limited (JSE:NPH) by estimating the company's 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Northam Platinum Holdings

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (ZAR, Millions)	R11.5b	R14.0b	R14.1b	R14.5b	R15.1b	R16.0b	R17.1b	R18.4b	R19.8b	R21.4b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Est @ 2.82%	Est @ 4.63%	Est @ 5.89%	Est @ 6.78%	Est @ 7.4%	Est @ 7.83%	Est @ 8.13%
Present Value (ZAR, Millions) Discounted @ 17%	R9.9k	R10.3k	R8.9k	R7.8k	R7.0k	R6.4k	R5.8k	R5.4k	R5.0k	R4.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = R71b

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 8.8%. We discount the terminal cash flows to today's value at a cost of equity of 17%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = R21b× (1 + 8.8%) ÷ (17%– 8.8%) = R299b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= R299b÷ ( 1 + 17%)¹⁰= R64b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is R135b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of R199, the company appears quite good value at a 47% 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.

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Northam Platinum 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 17%, which is based on a levered beta of 1.130. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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. Why is the intrinsic value higher than the current share price? For Northam Platinum Holdings, there are three further factors you should assess:

1. Risks: You should be aware of the 1 warning sign for Northam Platinum Holdings we've uncovered before considering an investment in the company.
2. Future Earnings: How does NPH'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 South African stock every day, so if you want to find the intrinsic value of any other stock 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.