TECOM Group PJSC's (DFM:TECOM) Intrinsic Value Is Potentially 41% Above Its Share Price

Key Insights

• TECOM Group PJSC's estimated fair value is د.إ3.1 based on 2 Stage Free Cash Flow to Equity
• Current share price of د.إ2.2 suggests TECOM Group PJSC is 29% undervalued
• Analyst price target for TECOM is د.إ2.82 which is 10.0% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of TECOM Group PJSC (DFM:TECOM) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for TECOM Group PJSC

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (AED, Millions)	د.إ1.31b	د.إ1.43b	د.إ1.56b	د.إ1.70b	د.إ1.85b	د.إ2.01b	د.إ2.19b	د.إ2.38b	د.إ2.60b	د.إ2.83b
Growth Rate Estimate Source	Est @ 8.97%	Est @ 8.94%	Est @ 8.92%	Est @ 8.90%	Est @ 8.89%	Est @ 8.89%	Est @ 8.88%	Est @ 8.88%	Est @ 8.88%	Est @ 8.87%
Present Value (AED, Millions) Discounted @ 17%	د.إ1.1k	د.إ1.0k	د.إ966	د.إ897	د.إ833	د.إ774	د.إ718	د.إ667	د.إ619	د.إ575

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = د.إ8.2b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 8.9%. We discount the terminal cash flows to today's value at a cost of equity of 17%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = د.إ2.8b× (1 + 8.9%) ÷ (17%– 8.9%) = د.إ37b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= د.إ37b÷ ( 1 + 17%)¹⁰= د.إ7.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is د.إ16b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of د.إ2.2, the company appears a touch undervalued at a 29% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

Now 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 evaluation of a company's future performance, so try the calculation yourself and check your own 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 TECOM Group PJSC 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 17%, which is based on a levered beta of 1.253. 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 TECOM Group PJSC

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for 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, the output can look very different. Why is the intrinsic value higher than the current share price? For TECOM Group PJSC, we've compiled three fundamental items you should explore:

1. Risks: As an example, we've found 1 warning sign for TECOM Group PJSC that you need to consider before investing here.
2. Future Earnings: How does TECOM'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Emirian stock every day, so if you want to find the intrinsic value of any other stock 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.