Is There An Opportunity With Bumi Armada Berhad's (KLSE:ARMADA) 36% Undervaluation?

Key Insights

• Bumi Armada Berhad's estimated fair value is RM0.76 based on 2 Stage Free Cash Flow to Equity
• Bumi Armada Berhad is estimated to be 36% undervalued based on current share price of RM0.48
• The RM0.66 analyst price target for ARMADA is 13% less than our estimate of fair value

Does the June share price for Bumi Armada Berhad (KLSE:ARMADA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Bumi Armada Berhad

Is Bumi Armada Berhad Fairly Valued?

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 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, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MYR, Millions)	RM986.7m	RM1.07b	RM891.2m	RM797.9m	RM748.0m	RM723.3m	RM714.2m	RM715.7m	RM724.3m	RM738.2m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Est @ -10.47%	Est @ -6.26%	Est @ -3.31%	Est @ -1.25%	Est @ 0.20%	Est @ 1.21%	Est @ 1.92%
Present Value (MYR, Millions) Discounted @ 20%	RM825	RM748	RM521	RM390	RM306	RM247	RM204	RM171	RM145	RM123

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM3.7b

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 20%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = RM738m× (1 + 3.6%) ÷ (20%– 3.6%) = RM4.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM4.8b÷ ( 1 + 20%)¹⁰= RM798m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM4.5b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.5, the company appears quite good value at a 36% 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.

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 Bumi Armada 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 20%, which is based on a levered beta of 2.000. 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 Bumi Armada Berhad

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?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Bumi Armada Berhad, we've compiled three fundamental aspects you should further research:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Bumi Armada Berhad .
2. Future Earnings: How does ARMADA'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.