Estimating The Intrinsic Value Of ECA Integrated Solution Berhad (KLSE:ECA)

Key Insights

• ECA Integrated Solution Berhad's estimated fair value is RM0.34 based on 2 Stage Free Cash Flow to Equity
• ECA Integrated Solution Berhad's RM0.28 share price indicates it is trading at similar levels as its fair value estimate
• The average premium for ECA Integrated Solution Berhad's competitorsis currently 60%

How far off is ECA Integrated Solution Berhad (KLSE:ECA) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for ECA Integrated Solution Berhad

What's The Estimated Valuation?

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 begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (MYR, Millions)	RM4.16m	RM5.98m	RM7.88m	RM9.71m	RM11.4m	RM12.9m	RM14.2m	RM15.4m	RM16.5m	RM17.5m
Growth Rate Estimate Source	Est @ 61.04%	Est @ 43.80%	Est @ 31.74%	Est @ 23.29%	Est @ 17.38%	Est @ 13.24%	Est @ 10.34%	Est @ 8.31%	Est @ 6.89%	Est @ 5.90%
Present Value (MYR, Millions) Discounted @ 9.4%	RM3.8	RM5.0	RM6.0	RM6.8	RM7.3	RM7.5	RM7.6	RM7.5	RM7.4	RM7.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM66m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (3.6%) 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 9.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = RM17m× (1 + 3.6%) ÷ (9.4%– 3.6%) = RM313m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM313m÷ ( 1 + 9.4%)¹⁰= RM128m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM194m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM0.3, the company appears about fair value at a 18% 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.

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 ECA Integrated Solution 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 accounts for debt. In this calculation we've used 9.4%, which is based on a levered beta of 1.035. 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. 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. For ECA Integrated Solution Berhad, there are three fundamental elements you should further research:

1. Risks: We feel that you should assess the 3 warning signs for ECA Integrated Solution Berhad (1 can't be ignored!) we've flagged before making an investment in the company.
2. Future Earnings: How does ECA'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 Malaysian 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.