Key Insights

• Using the 2 Stage Free Cash Flow to Equity, NetLink NBN Trust fair value estimate is S$1.72

• Current share price of S$0.90 suggests NetLink NBN Trust is potentially 48% undervalued

• Analyst price target for CJLU is S$0.97 which is 44% below our fair value estimate

Does the November share price for NetLink NBN Trust (SGX:CJLU) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for NetLink NBN Trust

The Method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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

("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = S$1.8b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 5.5%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = S$271m× (1 + 2.2%) ÷ (5.5%– 2.2%) = S$8.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$8.4b÷ ( 1 + 5.5%)10= S$4.9b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is S$6.7b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of S$0.9, the company appears quite undervalued at a 48% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 NetLink NBN Trust 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 5.5%, 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 NetLink NBN Trust

Strength

• Debt is not viewed as a risk.

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

Dividend information for CJLU.

Weakness

• Earnings declined over the past year.

Opportunity

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

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

Threat

• Dividends are not covered by earnings and cashflows.

• Annual earnings are forecast to grow slower than the Singaporean market.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For NetLink NBN Trust, we've compiled three fundamental factors you should consider:

1. Risks: For instance, we've identified 1 warning sign for NetLink NBN Trust that you should be aware of.

2. Future Earnings: How does CJLU'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.

3. 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!