Are Hyundai Motor Company Investors (KRX: 005380) Paying Above Embedded Value?
Today we are going to review a valuation method used to estimate the attractiveness of Hyundai Motor Company (KRX: 005380) as an investment opportunity by taking the company’s expected future cash flows and by discounting them to their current value. Our analysis will use the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are learning equity analysis in depth, the Simply Wall St analysis template here may be of interest to you.
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Does Hyundai Motor Have Fair Value?
We use what is called a 2-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to estimate the next ten years of cash flow. 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 the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, 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 the present value:
10-year Free Cash Flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF (₩, million) | ₩ 2.26 t | ₩ 3.53 t | ₩ 4.19t | ₩ 4.70 t | ₩ 5.15 t | ₩ 5.55 t | ₩ 5.92 t | ₩ 6.26 t | ₩ 6.57 t | ₩ 6.88 t |
Source of estimated growth rate | Analyst x11 | Analyst x13 | Analyst x9 | Is at 12.1% | Is 9.57% | Is 7.8% | Is 6.57% | Is 5.7% | Is 5.09% | Is 4.67% |
Present value (₩, million) discounted at 16% | ₩ 1.96 m | ₩ 2.65 m | ₩ 2.71 m | ₩ 2.63 m | ₩ 2.50 m | ₩ 2.33 m | ₩ 2.15 m | ₩ 1.96 m | ₩ 1.78 m | ₩ 1.61 m |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = ₩ 22t
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 3.7%. We discount terminal cash flows to their present value at a cost of equity of 16%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = ₩ 6.9t × (1 + 3.7%) ÷ (16% – 3.7%) = ₩ 60t
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= ₩ 60t ÷ (1 + 16%)^{ten}= ₩ 14t
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ₩ 36t. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current stock price of k 218k, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
The hypotheses
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and of course the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Hyundai Motor 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 into account debt. In this calculation, we used 16%, which is based on a leveraged beta of 2,000. Beta is a measure of the volatility of a stock, relative 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.
Next steps:
While important, the DCF calculation is just one of the many factors you need to assess for a business. DCF models are not the alpha and omega 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 undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Can we understand why the company trades at a premium over its intrinsic value? For Hyundai Motor, we have put together three fundamental aspects that you need to assess:
- Risks: For example, we have identified 3 warning signs for Hyundai Motor (I’m not very good with us) you have to be aware.
- Future income: How does A005380’s growth rate compare to its competition and the overall market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each KOSE share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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