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A Look At The Intrinsic Value Of The Hour Glass Limited (SGX:AGS)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Hour Glass fair value estimate is S$1.63

  • With S$1.61 share price, Hour Glass appears to be trading close to its estimated fair value

  • Peers of Hour Glass are currently trading on average at a 16% premium

Today we will run through one way of estimating the intrinsic value of The Hour Glass Limited (SGX:AGS) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

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See our latest analysis for Hour Glass

The Model

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

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (SGD, Millions)

S$77.5m

S$68.9m

S$64.0m

S$61.2m

S$59.7m

S$59.0m

S$58.9m

S$59.2m

S$59.8m

S$60.5m

Growth Rate Estimate Source

Est @ -16.75%

Est @ -11.11%

Est @ -7.16%

Est @ -4.40%

Est @ -2.46%

Est @ -1.11%

Est @ -0.16%

Est @ 0.50%

Est @ 0.97%

Est @ 1.29%

Present Value (SGD, Millions) Discounted @ 7.1%

S$72.4

S$60.1

S$52.1

S$46.5

S$42.3

S$39.1

S$36.4

S$34.2

S$32.2

S$30.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S$446m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = S$61m× (1 + 2.1%) ÷ (7.1%– 2.1%) = S$1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$1.2b÷ ( 1 + 7.1%)10= S$616m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is S$1.1b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of S$1.6, the company appears about fair value at a 1.4% 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.

dcf
dcf

The 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. 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 Hour Glass 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 7.1%, which is based on a levered beta of 1.098. 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.

SWOT Analysis for Hour Glass

Strength

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.

Opportunity

  • Current share price is below our estimate of fair value.

  • Lack of analyst coverage makes it difficult to determine AGS' earnings prospects.

Threat

  • No apparent threats visible for AGS.

Moving On:

Whilst important, the DCF calculation 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. 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 Hour Glass, we've compiled three fundamental elements you should further research:

  1. Risks: You should be aware of the 1 warning sign for Hour Glass we've uncovered before considering an investment in the company.

  2. 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!

  3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SGX every day. If you want to find the calculation for other stocks 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.