A Look At The Intrinsic Value Of Steel & Tube Holdings Limited (NZSE:STU)

editorial-team@simplywallst.com (Simply Wall St)

Sun, Oct 8, 2023, 7:33 PM 6 min read

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Steel & Tube Holdings Limited (NZSE:STU) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Steel & Tube Holdings

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NZ$, Millions)	NZ$37.4m	NZ$25.1m	NZ$18.9m	NZ$15.8m	NZ$14.1m	NZ$13.1m	NZ$12.5m	NZ$12.3m	NZ$12.1m	NZ$12.2m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -24.67%	Est @ -16.58%	Est @ -10.91%	Est @ -6.94%	Est @ -4.17%	Est @ -2.22%	Est @ -0.86%	Est @ 0.09%
Present Value (NZ$, Millions) Discounted @ 9.2%	NZ$34.3	NZ$21.1	NZ$14.5	NZ$11.1	NZ$9.1	NZ$7.7	NZ$6.8	NZ$6.1	NZ$5.5	NZ$5.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$121m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = NZ$12m× (1 + 2.3%) ÷ (9.2%– 2.3%) = NZ$182m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NZ$182m÷ ( 1 + 9.2%)¹⁰= NZ$76m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$197m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of NZ$1.1, the company appears about fair value at a 4.8% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf — NZSE:STU Discounted Cash Flow October 9th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Steel & Tube Holdings 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 9.2%, which is based on a levered beta of 1.370. 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 Steel & Tube Holdings

Strength

Currently debt free.

Dividends are covered by earnings and cash flows.

Dividend is in the top 25% of dividend payers in the market.

Weakness

Earnings declined over the past year.

Opportunity

Annual earnings are forecast to grow for the next 3 years.

Good value based on P/E ratio and estimated fair value.

Threat

No apparent threats visible for STU.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Steel & Tube Holdings, we've put together three further factors you should explore:

Risks: For example, we've discovered 2 warning signs for Steel & Tube Holdings that you should be aware of before investing here.
Future Earnings: How does STU's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
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 is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NZSE every day. If you want to find the calculation for other stocks 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.