Estimating The Fair Value Of Far East Holdings Berhad (KLSE:FAREAST)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Far East Holdings Berhad (KLSE:FAREAST) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 Far East Holdings Berhad

Step by step through the calculation

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (MYR, Millions)	RM29.8m	RM46.4m	RM64.8m	RM83.6m	RM101.5m	RM117.8m	RM132.4m	RM145.3m	RM156.8m	RM167.3m
Growth Rate Estimate Source	Est @ 77.4%	Est @ 55.29%	Est @ 39.81%	Est @ 28.98%	Est @ 21.4%	Est @ 16.09%	Est @ 12.37%	Est @ 9.77%	Est @ 7.95%	Est @ 6.67%
Present Value (MYR, Millions) Discounted @ 9.3%	RM27.3	RM38.8	RM49.6	RM58.6	RM65.1	RM69.1	RM71.1	RM71.4	RM70.5	RM68.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM590m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 3.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.3%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = RM167m× (1 + 3.7%) ÷ (9.3%– 3.7%) = RM3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM3.1b÷ ( 1 + 9.3%)¹⁰= RM1.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM1.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM2.9, the company appears about fair value at a 7.7% 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

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. 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 Far East Holdings 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 9.3%, 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.

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. The DCF model is not a perfect stock valuation tool. 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 Far East Holdings Berhad, we've compiled three further aspects you should look at:

1. Risks: Be aware that Far East Holdings Berhad is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
2. 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!
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. Simply Wall St updates its DCF calculation for every Malaysian stock every day, so if you want to find the intrinsic value of any other stock 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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