Stock Analysis

Abu Dhabi National Energy Company PJSC's (ADX:TAQA) Intrinsic Value Is Potentially 48% Above Its Share Price

ADX:TAQA
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Abu Dhabi National Energy Company PJSC (ADX:TAQA) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Abu Dhabi National Energy Company PJSC

The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, 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.إ15.9b د.إ17.4b د.إ27.0b د.إ32.9b د.إ38.9b د.إ44.8b د.إ50.8b د.إ56.9b د.إ63.1b د.إ69.7b
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Est @ 21.91% Est @ 18.00% Est @ 15.26% Est @ 13.34% Est @ 12.00% Est @ 11.06% Est @ 10.40%
Present Value (AED, Millions) Discounted @ 14% د.إ14.0k د.إ13.5k د.إ18.3k د.إ19.6k د.إ20.3k د.إ20.6k د.إ20.5k د.إ20.2k د.إ19.7k د.إ19.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = د.إ186b

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (8.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 14%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = د.إ70b× (1 + 8.9%) ÷ (14%– 8.9%) = د.إ1.5t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= د.إ1.5t÷ ( 1 + 14%)10= د.إ418b

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.إ604b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of د.إ3.6, the company appears quite undervalued at a 32% 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.

dcf
ADX:TAQA Discounted Cash Flow January 4th 2023

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 14%, 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.

SWOT Analysis for Abu Dhabi National Energy Company PJSC

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.
Opportunity
  • Annual earnings are forecast to grow faster than the Emirian market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • No apparent threats visible for TAQA.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Abu Dhabi National Energy Company PJSC, there are three fundamental factors you should look at:

  1. Risks: For instance, we've identified 2 warning signs for Abu Dhabi National Energy Company PJSC that you should be aware of.
  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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.

Valuation is complex, but we're helping make it simple.

Find out whether Abu Dhabi National Energy Company PJSC is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.