A look at the fair value of Sangji Construction, Inc. (KOSDAQ:042940)

Key findings

• Using the 2-step free cash flow to equity, the fair value of Sangji Construction is ₩3,418
• Sangji Construction’s share price of ₩3,450 suggests that the share price is at a similar level to the estimated fair value
• Sangji Construction’s competitors appear to be trading at a higher premium to fair value, based on the industry average of -56%.

In this article, we will estimate the intrinsic value of Sangji Construction, Inc. (KOSDAQ:042940) by taking the company’s projected future cash flows and discounting them to today’s value. We will do this using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one method. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for Sangji Construction

The calculation

We use the two-stage growth model, which simply means that we consider two stages of the company’s growth. In the early stage, the company may have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to get estimates of the next ten years of cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = ₩24b

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.5%) 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 11%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₩4.0b× (1 + 2.5%) ÷ (11%– 2.5%) = ₩48b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= ₩48b÷ ( 1 + 11%)¹⁰= ₩17b

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is ₩41 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ₩3.5 thousand, the company seems about fair at the time of writing. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore does not provide a complete picture of a company’s potential performance. Since we are considering Sangji Construction 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 takes debt into account. In this calculation, we used 11%, which is based on a levered beta of 1.617. Beta is a measure of a stock’s volatility relative to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with a set limit of 0.8 to 2.0, which is a reasonable range for a stable company.

Looking ahead:

While a company’s valuation is important, it is only one of many factors you need to evaluate for a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Sangji Construction, we have compiled three relevant points for you to evaluate:

1. Risks: For example, we found 3 warning signs for Sangji Construction that you should know.
2. 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 you might be missing out on!
3. Other environmentally friendly companies: Are you concerned about the environment and believe that consumers will increasingly buy environmentally friendly products? Browse through our interactive list of companies thinking about a greener future and discover some stocks you may not have thought of yet!

PS. Simply Wall St updates its DCF calculation for each South Korean stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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