Today we are going to walk through one way to estimate the intrinsic value of Pentamaster Corporation Berhad (KLSE:PENTA) by taking the company’s expected future cash flows and discounting them to the present value. Our analysis will use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for Pentamaster Corporation Berhad
What is the estimated valuation?
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (MYR, Millions)||RM91.7m||RM130.0m||RM192.9 million||RM234.9m||RM273.3m||RM307.4m||RM337.5m||RM364.3m||RM388.4m||RM410.5m|
|Growth rate estimate Source||Analyst x3||Analyst x3||Analyst x3||East @ 21.8%||Is at 16.32%||Is at 12.49%||Is at 9.81%||Is at 7.93%||Is at 6.62%||Is at 5.7%|
|Present Value (MYR, millions) discounted at 9.0%||RM84.1||RM109||RM149||RM166||RM178||RM183||RM185||RM183||RM179||RM173|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =RM1.6b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. 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 9.0%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = RM411m × (1 + 3.6%) ÷ (9.0%–3.6%) = RM7.8b
Present value of terminal value (PVTV)= TV / (1 + r)ten= RM7.8b÷ ( 1 + 9.0%)ten= RM3.3b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is RM4.9b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of RM3.9, the company appears to be pretty good value with a 43% 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. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Pentamaster Corporation 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 9.0%, which is based on a leveraged beta of 1.004. 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.
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Why is intrinsic value higher than the current stock price? For Pentamaster Corporation Berhad, we have compiled three relevant aspects for you to assess:
- Risks: For example, we have identified 1 warning sign for Pentamaster Corporation Berhad of which you should be aware.
- Future earnings: How does PENTA’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- 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!
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.