Key Insights

The projected fair value for Chorus is NZ$14.54 based on 2 Stage Free Cash Flow to Equity Chorus' NZ$8.16 share price signals that it might be 44% undervalued The NZ$7.68 analyst price target for CNU is 47% less than our estimate of fair value

Does the July share price for Chorus Limited (NZSE:CNU) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Chorus

What's The Estimated Valuation?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (NZ$, Millions)  NZ$223.5m NZ$293.0m NZ$316.0m NZ$343.0m NZ$344.0m NZ$346.9m NZ$351.3m NZ$356.8m NZ$363.1m NZ$370.0m Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x2 Analyst x2 Est @ 0.86% Est @ 1.27% Est @ 1.56% Est @ 1.76% Est @ 1.90% Present Value (NZ$, Millions) Discounted @ 7.0%  NZ$209 NZ$256 NZ$258 NZ$262 NZ$245 NZ$231 NZ$219 NZ$208 NZ$198 NZ$188

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$2.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) 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 7.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = NZ$370m× (1 + 2.2%) ÷ (7.0%– 2.2%) = NZ$8.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$8.0b÷ ( 1 + 7.0%)10= NZ$4.1b

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$6.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$8.2, the company appears quite undervalued at a 44% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Chorus 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 7.0%, which is based on a levered beta of 0.800. 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 Chorus

Strength

No major strengths identified for CNU.

Weakness

Earnings declined over the past year.

Interest payments on debt are not well covered.

Dividend is low compared to the top 25% of dividend payers in the Telecom market.

Opportunity

Annual earnings are forecast to grow faster than the New Zealander market.

Trading below our estimate of fair value by more than 20%.

Threat

Debt is not well covered by operating cash flow.

Dividends are not covered by earnings and cashflows.

Annual revenue is forecast to grow slower than the New Zealander market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Chorus, there are three pertinent items you should look at:

Risks: To that end, you should learn about the  4 warning signs  we've spotted with Chorus (including 2 which don't sit too well with us) . Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CNU's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here