V.S, just how much does it worth? kcchongnz

The secret to successful investing is to figure out the value of something-and then pay a lot less.”         Joel Grenblatt

We first discussed about what a No-Brainer Investment, NBI, is in this article:

http://klse.i3investor.com/blogs/kcchongnz/76694.jsp

“A NBI is one which provides you with a cash yield of double, triple, or more the cash you can get from a bank fixed deposit interest, in a consistent manner.”

Cash yield is the amount of free cash flow (FCF) with respect to its price, or FCF/Price.

Since V.S has no FCF left for the last three years due to its high requirement in working capitals and capital expenses, so it can’t be a NBI.

We also discussed if V.S is a great company here.

http://klse.i3investor.com/blogs/kcchongnz/77138.jsp

In my context, it isn’t as its average return on invested capital, ROIC is only 8.2% for the last 5 years which is less than its cost of capital of about 10%. Even at its best four quarters results in the last trailing 12 months, its ROIC is only about 9%. Please bear in mind that when the ROIC is less than the cost of capital, don’t fancy the high growth of the business of a company, as high growth is a bigger shareholder destroyer.

In the same thread above, we also discussed if V.S at RM4.33 is cheap or not, and my conclusion is it is not cheap, as even taking its best latest twelve months results, it after-tax earnings yield (NOPAT/Enterprise value) is only 6.5%, far below my minimum requirement of 10%.

But just how much does V.S worth? We will deal with this controversial topic of discount cash flow analysis. Constructive criticisms are highly appreciated.

Discount cash flow analysis (DCFA)
Financial theory postulated by John Burr Williams in his “The theory of investment value” suggests that the value of a stock is worth all of the future free cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate. This is similar to what Seth Klarman described as the Net Present Value analysis in his book “Margin of Safety” which he said is the most appropriate method to be used to value a company of on-going concern. Arguably the best reason to like DCFA is that it produces the closest thing to an Intrinsic Value.




There are two major assumptions in using the DCFA:

1) The free cash flows for the firm (FCFF) for all future years. Obviously, this is a difficult task to forecast the future cash flows not only for us as retail investors, but also for the professional analysts. Alternatively we can base on its existing business and its previous performance and make a guess on the growth rate of these free cash flows. This estimate doesn’t have to be accurate. Just be reasonable and use common sense.

2) The discount rate. This is the rate at which you discount future cash flows.

Estimating Free Cash Flow of V.S
Table 1 in the Appendix shows that V.S’s FCF has been negative for the last three years. Its average FCF for the last 5 years is only RM4.3m. That is very little of FCF for a firm having a total of 205m shares outstanding. Using this average FCF as a base estimate will yield a very low intrinsic value (IV) for V.S. So let us be a little liberal and base on its latest last twelve months results to estimate the free cash flows of the firm, FCFF, from its trailing twelve months net operating profit after tax (NOPAT) of RM103.4m. That is another liberal assumption in my opinion.

What would the growth rate of its NOPAT and hence its FCF?

Many analysts give all sorts of growth forecast when doing valuation. Yes, it is the future growth which is the key, not the past growth, though the past can be used as a guide. A growth rate of 5% and 15% for another 10 years makes a lot of difference to the intrinsic value of a firm, if the return on capital (ROC) is higher than the weighted average cost of capital (WACC). If ROC is about the same as WACC, it doesn’t make much difference. If ROIC<WACC, growth is a shareholder wealth destroyer. So how do we check if growth assumptions are reasonable?

One way is to estimate the expected growth rate from the fundamentals, assuming that the company does not take up more debts, no issuance of more shares, there is no spurts of its margins and everything remains the same. Those are plenty fair assumptions, aren’t they?

Expected Growth_EBIT, g = Reinvestment Rate, RR * Return on Capital, ROC

We will make another liberal assumption that its ROC will further improve beyond its best last trailing twelve month ROC of 9% to 10%. We also assume that from now on, its NOPAT will grow by 7%, better than its last 4 years’ growth of 4.9%. Remember as ROIC is about its WACC, which we assume to be 10%, growth doesn’t make much difference in its intrinsic value.

RR = g / ROC = 7% / 10% = 70%. This means V.S has to reinvest back 70% of its NOPAT

Reinvestment rate, RR = (change in net working capital + net capital expenses)/NOPAT

We will also use this same expected growth rate of 7% and the result of RR of 70% to estimate the growth of its FCFF for the next 5 years. After five years, it is assumed that its NOPAT will grow at a rate of 3%, something close to the growth of GDP.

Terminal reinvestment rate = Growth rate* ROC = 3% / 10% = 30%

The future FCFF for V.S is computed and tabulated in Table 2 in the Appendix using the above assumptions. The base FCFF for 2014 was computed as RM31m as shown.

Discount Free Cash Flow Analysis of V.S

Table 2 in the Appendix shows the detail step-by-step calculations of the intrinsic value for FCFF of V.S. The present value of FCFF was obtained by summing up those of first 5 years of supernormal growth value and the terminal value. After adding the excess cash, less off total debt, and after accounting for minority interest, gives the intrinsic value of V.S at RM3.83. This IV is below the present market price at RM4.25.
For those who are interested in the secret of successful investing, please contact me at
ckc14invest@gmail.com

K C Chong (2^nd June 2015)

Appendix

Table 1: Historical cash flows of V.S



Table 2: Estimating FCF and discount free cash flow analysis for V.S