Estimating The Fair Value Of Power Root Berhad (KLSE:PWROOT)

In this article we are going to estimate the intrinsic value of Power Root Berhad (KLSE:PWROOT) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Power Root Berhad

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. To begin with, we have to get estimates of 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.

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)	RM13.0m	RM27.3m	RM34.5m	RM34.6m	RM35.0m	RM35.6m	RM36.5m	RM37.5m	RM38.7m	RM39.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 0.15%	Est @ 1.19%	Est @ 1.92%	Est @ 2.43%	Est @ 2.79%	Est @ 3.04%	Est @ 3.21%
Present Value (MYR, Millions) Discounted @ 8.3%	RM12.0	RM23.2	RM27.1	RM25.1	RM23.4	RM22.1	RM20.9	RM19.8	RM18.8	RM17.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM210m

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 8.3%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = RM40m× (1 + 3.6%) ÷ (8.3%– 3.6%) = RM879m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM879m÷ ( 1 + 8.3%)¹⁰= RM395m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is RM605m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM1.7, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Power Root 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 8.3%, 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Power Root Berhad, we've compiled three fundamental elements you should explore:

1. Risks: We feel that you should assess the 2 warning signs for Power Root Berhad we've flagged before making an investment in the company.
2. Future Earnings: How does PWROOT'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. 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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