How far is SC Estate Builder Berhad (KLSE:SCBUILD) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by projecting its future cash flows and then discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it may seem quite complex.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest review for SC Estate Builder Berhad
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimates of free cash flow are available to us, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (MYR, Millions)||RM1.46m||RM2.23m||RM3.09m||RM3.94m||RM4.75m||RM5.49m||RM6.14m||RM6.71m||RM7.23m||RM7.69m|
|Growth rate estimate Source||Is at 74.29%||Is at 53.07%||East @ 38.21%||East @ 27.81%||East @ 20.54%||Is at 15.44%||Is at 11.87%||Is at 9.38%||Is at 7.63%||Is at 6.4%|
|Present value (MYR, millions) discounted at 9.1%||RM1.3||RM1.9||RM2.4||RM2.8||RM3.1||RM3.2||RM3.3||RM3.3||RM3.3||RM3.2|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = RM27m
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (3.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 9.1%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = RM7.7m × (1 + 3.6%) ÷ (9.1%– 3.6%) = RM142m
Present value of terminal value (PVTV)= TV / (1 + r)ten= RM142m÷ ( 1 + 9.1%)ten= RM59m
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is RM86 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.07, the company appears to be approximately fair value at a 19% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
We emphasize 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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider SC Estate Builder Berhad 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 takes debt into account. In this calculation, we used 9.1%, which is based on a leveraged beta of 1.031. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Although important, the DCF calculation is just one of many factors you need to assess for a business. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For SC Estate Builder Berhad, we have compiled three key aspects to consider:
- Risks: Take risks, for example – SC Estate Builder Berhad has 6 warning signs (and 2 that are a little concerning) that we think you should know about.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
- Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!
PS. Simply Wall St updates its DCF calculation for every Malaysian stock daily, so if you want to find the intrinsic value of any other stock, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.