Stock Analysis

Calculating The Fair Value Of Gamuda Berhad (KLSE:GAMUDA)

KLSE:GAMUDA
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Gamuda Berhad (KLSE:GAMUDA) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out the opportunities and risks within the MY Construction industry.

The 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. To start off with, we need to estimate 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.

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 (MYR, Millions) RM3.50b RM777.9m RM828.5m RM795.1m RM781.2m RM779.9m RM787.3m RM800.9m RM819.2m RM841.0m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Est @ -4.03% Est @ -1.75% Est @ -0.16% Est @ 0.95% Est @ 1.73% Est @ 2.28% Est @ 2.66%
Present Value (MYR, Millions) Discounted @ 12% RM3.1k RM625 RM597 RM513 RM452 RM405 RM366 RM334 RM306 RM282

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM7.0b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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)= FCF2032 × (1 + g) ÷ (r – g) = RM841m× (1 + 3.6%) ÷ (12%– 3.6%) = RM11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM11b÷ ( 1 + 12%)10= RM3.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM11b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM3.7, the company appears about fair value at a 9.1% 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.

dcf
KLSE:GAMUDA Discounted Cash Flow November 3rd 2022

The Assumptions

Now 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 12%, which is based on a levered beta of 1.220. 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 Gamuda Berhad

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Construction market.
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual revenue is forecast to grow faster than the Malaysian market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Dividends are not covered by cash flow.
  • Annual earnings are forecast to grow slower than the Malaysian market.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for 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?" 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 Gamuda Berhad, there are three relevant factors you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Gamuda Berhad , and understanding them should be part of your investment process.
  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.

Valuation is complex, but we're helping make it simple.

Find out whether Gamuda Berhad is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.