Stock Analysis

Are Investors Undervaluing Gamuda Berhad (KLSE:GAMUDA) By 50%?

KLSE:GAMUDA
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In this article we are going to estimate the intrinsic value of Gamuda Berhad (KLSE:GAMUDA) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

View our latest analysis for Gamuda 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. To begin with, we have to get estimates of 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (MYR, Millions) -RM12.1m RM301.3m RM781.4m RM1.16b RM1.57b RM1.98b RM2.36b RM2.70b RM3.00b RM3.27b
Growth Rate Estimate Source Analyst x3 Analyst x4 Analyst x3 Est @ 48.75% Est @ 35.23% Est @ 25.77% Est @ 19.15% Est @ 14.52% Est @ 11.27% Est @ 9%
Present Value (MYR, Millions) Discounted @ 13% -RM10.7 RM236 RM542 RM714 RM855 RM952 RM1.0k RM1.0k RM1.0k RM968

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM7.3b

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 13%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = RM3.3b× (1 + 3.7%) ÷ (13%– 3.7%) = RM37b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM37b÷ ( 1 + 13%)10= RM11b

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 RM18b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM3.6, the company appears quite undervalued at a 50% 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.

dcf
KLSE:GAMUDA Discounted Cash Flow January 13th 2021

Important assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Gamuda 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 13%, which is based on a levered beta of 1.324. 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 shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. Can we work out why the company is trading at a discount to intrinsic value? For Gamuda Berhad, we've compiled three further elements you should explore:

  1. Risks: As an example, we've found 3 warning signs for Gamuda Berhad (1 shouldn't be ignored!) that you need to consider before investing here.
  2. Future Earnings: How does GAMUDA'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. 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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