How far off is Gadang Holdings Berhad (KLSE:GADANG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.
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
|Levered FCF (MYR, Millions)||RM14.5m||RM20.5m||RM26.6m||RM32.4m||RM37.8m||RM42.6m||RM46.8m||RM50.6m||RM54.0m||RM57.2m|
|Growth Rate Estimate Source||Est @ 57.06%||Est @ 41.05%||Est @ 29.85%||Est @ 22%||Est @ 16.51%||Est @ 12.67%||Est @ 9.98%||Est @ 8.09%||Est @ 6.78%||Est @ 5.85%|
|Present Value (MYR, Millions) Discounted @ 16%||RM12.6||RM15.3||RM17.2||RM18.2||RM18.4||RM17.9||RM17.0||RM15.9||RM14.7||RM13.5|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM160m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (3.7%) 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 16%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = RM57m× (1 + 3.7%) ÷ (16%– 3.7%) = RM501m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM501m÷ ( 1 + 16%)10= RM118m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM278m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Gadang Holdings 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 16%, which is based on a levered beta of 1.694. 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.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. 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 Gadang Holdings Berhad, we've compiled three additional items you should look at:
- Risks: You should be aware of the 5 warning signs for Gadang Holdings Berhad (1 makes us a bit uncomfortable!) we've uncovered before considering an investment in the company.
- Future Earnings: How does GADANG'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.
- 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. 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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Gadang Holdings Berhad
Gadang Holdings Berhad, an investment holding company, engages in civil engineering and construction, property development, water supply, and mechanical and electrical engineering businesses in Malaysia, Indonesia, and Singapore.
Flawless balance sheet with reasonable growth potential.