Khong Guan's estimated fair value is S$1.33 based on 2 Stage Free Cash Flow to Equity
With S$1.17 share price, Khong Guan appears to be trading close to its estimated fair value
Khong Guan's peers seem to be trading at a higher discount to fair value based onthe industry average of 48%
How far off is Khong Guan Limited (SGX:K03) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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.
See our latest analysis for Khong Guan
Crunching The Numbers
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (SGD, Millions)
S$962.5k
S$1.08m
S$1.17m
S$1.25m
S$1.32m
S$1.38m
S$1.43m
S$1.48m
S$1.52m
S$1.56m
Growth Rate Estimate Source
Est @ 16.08%
Est @ 11.87%
Est @ 8.93%
Est @ 6.86%
Est @ 5.42%
Est @ 4.41%
Est @ 3.70%
Est @ 3.21%
Est @ 2.86%
Est @ 2.62%
Present Value (SGD, Millions) Discounted @ 5.7%
S$0.9
S$1.0
S$1.0
S$1.0
S$1.0
S$1.0
S$1.0
S$0.9
S$0.9
S$0.9
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = S$9.6m
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 (2.1%) 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 5.7%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$43m÷ ( 1 + 5.7%)10= S$25m
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 S$34m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of S$1.2, the company appears about fair value at a 12% 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.
SGX:K03 Discounted Cash Flow March 15th 2024
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Khong Guan 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 5.7%, which is based on a levered beta of 0.800. 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 Khong Guan
Strength
Currently debt free.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
Opportunity
Has sufficient cash runway for more than 3 years based on current free cash flows.
Current share price is below our estimate of fair value.
Lack of analyst coverage makes it difficult to determine K03's earnings prospects.
Threat
No apparent threats visible for K03.
Looking Ahead:
Whilst important, the DCF calculation 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. 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 Khong Guan, we've compiled three essential elements you should further examine:
Risks: You should be aware of the 2 warning signs for Khong Guan (1 can't be ignored!) we've uncovered before considering an investment in the company.
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!
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. Simply Wall St updates its DCF calculation for every Singaporean 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.
