Calculating The Intrinsic Value Of Kelly Partners Group Holdings Limited (ASX:KPG)

Key Insights

• Kelly Partners Group Holdings' estimated fair value is AU$7.56 based on 2 Stage Free Cash Flow to Equity

• Current share price of AU$7.95 suggests Kelly Partners Group Holdings is potentially trading close to its fair value

• The average discount for Kelly Partners Group Holdings' competitorsis currently 15%

Does the June share price for Kelly Partners Group Holdings Limited (ASX:KPG) 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. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Kelly Partners Group Holdings

Step By Step Through 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. 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, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$15.0m	AU$15.3m	AU$15.6m	AU$15.9m	AU$16.3m	AU$16.6m	AU$17.0m	AU$17.4m	AU$17.8m	AU$18.2m
Growth Rate Estimate Source	Est @ 1.95%	Est @ 2.04%	Est @ 2.11%	Est @ 2.15%	Est @ 2.19%	Est @ 2.21%	Est @ 2.22%	Est @ 2.23%	Est @ 2.24%	Est @ 2.25%
Present Value (A$, Millions) Discounted @ 6.6%	AU$14.0	AU$13.4	AU$12.9	AU$12.3	AU$11.8	AU$11.3	AU$10.9	AU$10.4	AU$10.0	AU$9.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$117m

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 (2.3%) 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 6.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$18m× (1 + 2.3%) ÷ (6.6%– 2.3%) = AU$425m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$425m÷ ( 1 + 6.6%)¹⁰= AU$224m

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 AU$340m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$8.0, the company appears around fair value at the time of writing. 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

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 Kelly Partners Group 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 6.6%, which is based on a levered beta of 0.951. 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. DCF models are not the be-all and end-all of investment valuation. 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. For Kelly Partners Group Holdings, we've put together three further aspects you should explore:

1. Risks: For example, we've discovered 3 warning signs for Kelly Partners Group Holdings that you should be aware of before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for KPG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. 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!

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com