The intrinsic value of LG H&H Co., Ltd. (KRX:051900) may be 63% above the share price

Key findings

• The projected fair value for LG H&H is ₩587,012 based on the 2-step Free Cash Flow to Equity
• LG H&H’s share price of ₩360,500 suggests the company may be undervalued by 39%
• The analyst price target of ₩432,609 for A051900 is 26% below our fair value estimate

Today we will go through one way to estimate the intrinsic value of LG H&H Co., Ltd. (KRX:051900) by taking the expected future cash flows and discounting them to today’s value. One way to do this is to apply the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We would like to point out that there are many ways to value a company and that each method, like the DCF, has advantages and disadvantages in certain scenarios. If you still have questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for LG H&H

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 might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. In the first stage, we need to estimate the company’s cash flows for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or 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 based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s 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) = 4.0t

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 8.0%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = ₩679b × (1 + 2.5%) ÷ (8.0% – 2.5%) = ₩13t

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= ₩13t÷ ( 1 + 8.0 %)¹⁰= ₩5.8t

The total value or equity value is then the sum of the present value of future cash flows, which in this case is ₩9.8 trillion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of ₩361,000, the company appears quite undervalued at a 39% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep that in mind.

The assumptions

The main inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider LG H&H 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 8.0%, which is based on a leveraged beta of 1.039. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for LG H&H

Next Steps:

Valuation is only one side of the coin in building your investment thesis and just one of many factors you need to evaluate for a company. DCF models are not the be-all and end-all of investment valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. What is the reason for the share price being below the intrinsic value? For LG H&H, we have compiled three key points for you to examine in more detail:

1. Risks: Take risks, for example – LG H&H has 2 warning signs In our opinion, you should be aware of this.
2. Future income: How does A051900’s growth rate compare to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

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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