Estimated fair value of New Hope Corporation Limited (ASX:NHC)

Does the October share price for New Hope Corporation Limited (ASX:NHC) reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by estimating the future cash flows of the company and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you still have burning questions about this type of assessment, take a look at the Simply Wall St Analysis Template.

Check opportunities and risks within the AU oil and gas industry.

The method

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (A$, Millions) AU$1.66 billion A$1.76 billion A$712.0 million A$199.0 million A$350.0 million A$198.0 million A$138.9 million A$110.7 million A$95.6 million A$86.9 million
Growth rate estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x1 Analyst x1 Is @ -43.43% Is @ -29.84% Is @ -20.33% Is @ -13.67% Is @ -9.01%
Present value (A$, millions) discounted at 7.5% AU$1.5,000 AU$1.5,000 AU$573 AU$149 AU$244 AU$128 AU$83.8 AU$62.1 AU$49.9 AU$42.2

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = AU$4.4 billion

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 7.5%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = AU$87 million × (1 + 1.9%) ÷ (7.5%–1.9%) = AU$1.6 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= AU$1.6 billion÷ ( 1 + 7.5%)ten= AU$766 million

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is A$5.2 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of AU$6.9, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.

ASX: NHC Discounted Cash Flow October 17, 2022

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view New Hope 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 factors in debt. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.200. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for a new hope

Strength
  • Earnings growth over the past year has exceeded that of the industry.
  • Debt is not considered a risk.
  • Dividends are covered by earnings and cash flow.
  • The dividend is among the top 25% dividend payers in the market.
Weakness
  • Shareholders have been diluted over the past year.
Opportunity
  • Good value based on the P/E ratio compared to the estimated Fair P/E ratio.
  • Significant insider buying in the last 3 months.
Threatens
  • Annual revenues are expected to decline over the next 3 years.

Look forward:

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of 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 pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For New Hope, there are three important factors you should explore:

  1. Risks: Take for example the ubiquitous specter of investment risk. We have identified 3 warning signs with New Hope (at least 1 of which are potentially serious), and understanding them should be part of your investment process.
  2. Management:Did insiders increase their shares to take advantage of market sentiment about NHC’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks, search here.

Valuation is complex, but we help make it simple.

Find out if A new hope is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

See the free analysis

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Comments are closed.