Estimating The Intrinsic Value Of Alpha Ocean Resources Berhad (KLSE:AORB)

In this article we are going to estimate the intrinsic value of Alpha Ocean Resources Berhad (KLSE:AORB) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Alpha Ocean Resources Berhad

The Method

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 begin with, we have to get estimates of the next ten years of cash flows. 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MYR, Millions)	RM4.29m	RM6.36m	RM8.57m	RM10.8m	RM12.8m	RM14.6m	RM16.2m	RM17.7m	RM18.9m	RM20.1m
Growth Rate Estimate Source	Est @ 67.42%	Est @ 48.26%	Est @ 34.85%	Est @ 25.46%	Est @ 18.89%	Est @ 14.29%	Est @ 11.06%	Est @ 8.81%	Est @ 7.23%	Est @ 6.13%
Present Value (MYR, Millions) Discounted @ 7.9%	RM4.0	RM5.5	RM6.8	RM7.9	RM8.7	RM9.3	RM9.5	RM9.6	RM9.6	RM9.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM80m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (3.6%) 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 7.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = RM20m× (1 + 3.6%) ÷ (7.9%– 3.6%) = RM479m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM479m÷ ( 1 + 7.9%)¹⁰= RM224m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM304m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of RM2.6, the company appears about fair value at a 14% 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.

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 Alpha Ocean Resources 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 7.9%, which is based on a levered beta of 0.800. 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.

Next Steps:

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. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Alpha Ocean Resources Berhad, we've compiled three pertinent elements you should look at:

1. Risks: You should be aware of the 3 warning signs for Alpha Ocean Resources Berhad (1 is a bit concerning!) we've uncovered before considering an investment in the company.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.