An Intrinsic Calculation For National Central Cooling Company PJSC (DFM:TABREED) Suggests It's 23% Undervalued

Key Insights

• National Central Cooling Company PJSC's estimated fair value is د.إ3.9 based on 2 Stage Free Cash Flow to Equity
• Current share price of د.إ3.0 suggests National Central Cooling Company PJSC is 23% undervalued
• National Central Cooling Company PJSC's peers are currently trading at a premium of 168% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of National Central Cooling Company PJSC (DFM:TABREED) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for National Central Cooling 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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (AED, Millions)	د.إ684.0m	د.إ599.0m	د.إ611.0m	د.إ809.0m	د.إ905.0m	د.إ994.4m	د.إ1.09b	د.إ1.19b	د.إ1.30b	د.إ1.42b
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 9.88%	Est @ 9.58%	Est @ 9.36%	Est @ 9.22%	Est @ 9.11%
Present Value (AED, Millions) Discounted @ 15%	د.إ596	د.إ455	د.إ405	د.إ467	د.إ455	د.إ436	د.إ416	د.إ397	د.إ378	د.إ359

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = د.إ4.4b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 15%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = د.إ1.4b× (1 + 8.9%) ÷ (15%– 8.9%) = د.إ26b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= د.إ26b÷ ( 1 + 15%)¹⁰= د.إ6.7b

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.إ11b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of د.إ3.0, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 National Central Cooling 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 15%, which is based on a levered beta of 0.875. 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 National Central Cooling Company PJSC

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For National Central Cooling Company PJSC, we've compiled three important elements you should further examine:

1. Risks: For example, we've discovered 2 warning signs for National Central Cooling Company PJSC (1 is significant!) that you should be aware of before investing here.
2. Future Earnings: How does TABREED'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the DFM every day. If you want to find the calculation for other stocks 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.