What’s The Real Value Of StarHub Ltd Stock?

Telecommunications services provider StarHub Ltd (SGX: CC3) has a stock price of S$3.34 currently. Is that a bargain, incredibly over-priced, or somewhere in between?

A good way to find out would be to try and estimate the real value of StarHub’s stock. One way to do so is by using the Discounted Cash Flow (DCF) model.

In search of value

A DCF model essentially sums up all the cash a company can produce over its lifetime before discounting them back to the present.

The popular way to estimate that amount of cash would be to first predict how fast a company can grow its free cash flows over the next 10 years. This is followed by guessing how fast the company can grow its free cash flows from the 11th year onward to perpetuity; this is known as the terminal growth rate.

But, there are issues with using a DCF model. For instance, investors have to estimate how much cash a company can produce – in essence, that’s trying to project future cash flows and the future can be hard to predict. In his book Value Investing: Tools and Techniques for Intelligent Investment, investor James Montier wrote that DCF models have “problems with estimating cash flows, and problems with estimating the discount rate.”

To counter some of these roadblocks, Montier suggested investors use a reverse-engineered DCF model instead. The reverse-engineered DCF model looks at a stock’s current price to determine what sort of growth rates are implied by the market at that price.

Punching in the numbers

So, let’s use a reverse-engineered DCF model on StarHub and see what we can find. To produce a reverse-engineered DCF model, some of the starting ingredients required are:

  • The company’s current stock price
  • The free cash flow per share generated over the last 12 months
  • A discount rate
  • A terminal growth rate for the company’s cash flows

As mentioned earlier, StarHub’s current stock price is S$3.34. According to S&P Global Market Intelligence, StarHub’s trailing free cash flow per share is S$0.125 (free cash flow of S$216 million divided by a share count of 1.73 billion).

For the discount rate, I’d be using my own required rate of return (also known as the hurdle rate), which I’m setting as 15% here. Do note that there’s a different version of the discount rate, one which takes into account the current rate of return for a risk free investment, the equity-risk premium, and the stock’s historical volatility in relation to the stock market.

Coming to the terminal growth rate, I’d simply set it as the historical rate of long-term inflation, which is around 2% to 3% for Singapore. I’d use 3% here.

So, to sum up what we have at the moment:

  • The company’s current stock price: S$3.34
  • The free cash flow per share generated over the last 12 months: S$0.125
  • A discount rate: 15%
  • A terminal growth rate for the company’s cash flows: 3%

With the figures just above, my calculations show that the market expects StarHub’s free cash flow per share to grow by 26.2% annually over the next five years, and then by 13.1% over the next five year block of time. The table below gives a pictorial representation of this:

StarHub implied free cash flow growth rate
Source: Author’s assumptions and calculations

We can then use the implied growth rates for StarHub’s free cash flow growth and compare it with our own views on the company’s ability to grow. If you think the implied growth rates are too low for StarHub, then the company will be a bargain at its current price of S$3.34. But, if you think the implied growth rates are way too ambitious a target, then StarHub could be an incredibly over-priced stock right now.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.