Key Insights
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Sembcorp Industries' estimated fair value is S$7.36 based on Dividend Discount Model
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With S$6.01 share price, Sembcorp Industries appears to be trading close to its estimated fair value
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Analyst price target for U96 is S$7.25 which is 1.5% below our fair value estimate
In this article we are going to estimate the intrinsic value of Sembcorp Industries Ltd ( SGX:U96 ) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model .
The Calculation
We have to calculate the value of Sembcorp Industries slightly differently to other stocks because it is a integrated utilities company. In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts. This often underestimates the value of a stock, but it can still be good as a comparison to competitors. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.5%. We then discount this figure to today's value at a cost of equity of 5.8%. Relative to the current share price of S$6.0, the company appears about fair value at a 18% 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.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= S$0.2 / (5.8% – 2.5%)
= S$7.4
Important 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Sembcorp Industries 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 5.8%, 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.
See our latest analysis for Sembcorp Industries
SWOT Analysis for Sembcorp Industries
Strength
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Earnings growth over the past year exceeded the industry.
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Debt is well covered by earnings.
Weakness
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Earnings growth over the past year is below its 5-year average.
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Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.
Opportunity
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Annual revenue is forecast to grow faster than the Singaporean market.
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Current share price is below our estimate of fair value.
Threat
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Debt is not well covered by operating cash flow.
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Dividends are not covered by cash flow.
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Annual earnings are forecast to grow slower than the Singaporean market.
Next Steps:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Sembcorp Industries, we've compiled three essential aspects you should consider:
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Risks: Take risks, for example - Sembcorp Industries has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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Future Earnings: How does U96'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 .
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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 SGX 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.
