Estimating The Fair Value Of FITTERS Diversified Berhad (KLSE:FITTERS)

In this article we are going to estimate the intrinsic value of FITTERS Diversified Berhad (KLSE:FITTERS) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. 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.

Check out our latest analysis for FITTERS Diversified Berhad

The calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (MYR, Millions)	RM12.0m	RM12.1m	RM12.3m	RM12.6m	RM12.9m	RM13.3m	RM13.7m	RM14.2m	RM14.6m	RM15.1m
Growth Rate Estimate Source	Est @ -0.38%	Est @ 0.82%	Est @ 1.66%	Est @ 2.25%	Est @ 2.66%	Est @ 2.95%	Est @ 3.15%	Est @ 3.29%	Est @ 3.39%	Est @ 3.46%
Present Value (MYR, Millions) Discounted @ 12%	RM10.8	RM9.7	RM8.9	RM8.1	RM7.5	RM6.9	RM6.4	RM5.9	RM5.5	RM5.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM74m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 3.6%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = RM15m× (1 + 3.6%) ÷ (12%– 3.6%) = RM199m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM199m÷ ( 1 + 12%)¹⁰= RM67m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is RM141m. 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 around fair value at the time of writing. 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.

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 FITTERS Diversified 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 12%, which is based on a levered beta of 1.342. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 FITTERS Diversified Berhad, we've put together three essential factors you should further examine:

1. Risks: To that end, you should learn about the 4 warning signs we've spotted with FITTERS Diversified Berhad (including 1 which shouldn't be ignored) .
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the KLSE 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. 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.
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