Calculating The Fair Value Of Kobay Technology Bhd. (KLSE:KOBAY)

Key Insights

• The projected fair value for Kobay Technology Bhd is RM1.33 based on 2 Stage Free Cash Flow to Equity
• Current share price of RM1.10 suggests Kobay Technology Bhd is potentially trading close to its fair value
• Peers of Kobay Technology Bhd are currently trading on average at a 56% premium

Today we will run through one way of estimating the intrinsic value of Kobay Technology Bhd. (KLSE:KOBAY) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for Kobay Technology Bhd

Crunching The Numbers

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM45.8m	RM42.2m	RM40.4m	RM39.7m	RM39.6m	RM39.9m	RM40.6m	RM41.5m	RM42.6m	RM43.8m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -4.21%	Est @ -1.88%	Est @ -0.25%	Est @ 0.89%	Est @ 1.69%	Est @ 2.25%	Est @ 2.64%	Est @ 2.91%
Present Value (MYR, Millions) Discounted @ 12%	RM41.0	RM33.9	RM29.0	RM25.5	RM22.8	RM20.6	RM18.8	RM17.2	RM15.8	RM14.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM239m

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)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM44m× (1 + 3.6%) ÷ (12%– 3.6%) = RM561m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM561m÷ ( 1 + 12%)¹⁰= RM186m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM426m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM1.1, the company appears about fair value at a 17% discount to where the stock price trades currently. 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Kobay Technology Bhd 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 1.187. 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 Kobay Technology Bhd

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Kobay Technology Bhd, there are three important factors you should further examine:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Kobay Technology Bhd .
2. Future Earnings: How does KOBAY'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 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!

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. 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.