Stock Analysis

Is Top Glove Corporation Bhd. (KLSE:TOPGLOV) Worth RM0.8 Based On Its Intrinsic Value?

KLSE:TOPGLOV
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Key Insights

  • The projected fair value for Top Glove Corporation Bhd is RM0.62 based on 2 Stage Free Cash Flow to Equity
  • Current share price of RM0.83 suggests Top Glove Corporation Bhd is potentially 35% overvalued
  • The RM0.57 analyst price target for TOPGLOV is 7.9% less than our estimate of fair value

Does the February share price for Top Glove Corporation Bhd. (KLSE:TOPGLOV) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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.

Check out our latest analysis for Top Glove Corporation Bhd

Is Top Glove Corporation Bhd 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (MYR, Millions) -RM233.4m RM114.0m RM269.7m RM346.0m RM412.0m RM462.6m RM507.4m RM547.2m RM583.1m RM616.1m
Growth Rate Estimate Source Analyst x5 Analyst x6 Analyst x6 Analyst x1 Analyst x1 Est @ 12.29% Est @ 9.68% Est @ 7.84% Est @ 6.56% Est @ 5.66%
Present Value (MYR, Millions) Discounted @ 11% -RM211 RM92.9 RM198 RM230 RM247 RM250 RM248 RM241 RM232 RM221

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM1.8b

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 11%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = RM616m× (1 + 3.6%) ÷ (11%– 3.6%) = RM8.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM8.9b÷ ( 1 + 11%)10= RM3.2b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM4.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of RM0.8, the company appears potentially overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
KLSE:TOPGLOV Discounted Cash Flow February 22nd 2023

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. 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 Top Glove Corporation 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 11%, which is based on a levered beta of 0.899. 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:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Top Glove Corporation Bhd, we've compiled three pertinent aspects you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Top Glove Corporation Bhd , and understanding this should be part of your investment process.
  2. Future Earnings: How does TOPGLOV'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.

Valuation is complex, but we're helping make it simple.

Find out whether Top Glove Corporation Bhd is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.