Abu Dhabi National Energy Company PJSC's (ADX:TAQA) Intrinsic Value Is Potentially 66% Above Its Share Price

Does the May share price for Abu Dhabi National Energy Company PJSC (ADX:TAQA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Abu Dhabi National Energy Company PJSC

The method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (AED, Millions)	د.إ10.5b	د.إ10.9b	د.إ10.5b	د.إ12.5b	د.إ13.3b	د.إ14.2b	د.إ15.3b	د.إ16.5b	د.إ17.9b	د.إ19.4b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Analyst x1	Est @ 6.25%	Est @ 7.06%	Est @ 7.63%	Est @ 8.03%	Est @ 8.31%	Est @ 8.5%
Present Value (AED, Millions) Discounted @ 13%	د.إ9.3k	د.إ8.6k	د.إ7.3k	د.إ7.7k	د.إ7.3k	د.إ6.9k	د.إ6.6k	د.إ6.3k	د.إ6.1k	د.إ5.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = د.إ72b

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 9.0%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = د.إ19b× (1 + 9.0%) ÷ (13%– 9.0%) = د.إ560b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= د.إ560b÷ ( 1 + 13%)¹⁰= د.إ169b

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.إ241b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of د.إ1.3, the company appears quite undervalued at a 40% 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.

Important 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 Abu Dhabi National Energy Company 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 13%, 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.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Abu Dhabi National Energy Company PJSC, we've put together three relevant items you should further research:

1. Risks: For example, we've discovered 1 warning sign for Abu Dhabi National Energy Company PJSC that you should be aware of before investing here.
2. Future Earnings: How does TAQA'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.