Is Top Glove Corporation Bhd. (KLSE:TOPGLOV) Worth RM1.1 Based On Its Intrinsic Value?

Key Insights

• Top Glove Corporation Bhd's estimated fair value is RM0.83 based on 2 Stage Free Cash Flow to Equity
• Top Glove Corporation Bhd is estimated to be 34% overvalued based on current share price of RM1.11
• The RM0.70 analyst price target for TOPGLOV is 15% less than our estimate of fair value

Does the May 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 expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View 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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MYR, Millions)	-RM282.9m	RM39.5m	RM254.4m	RM413.0m	RM526.0m	RM613.2m	RM690.9m	RM759.7m	RM820.7m	RM875.6m
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x5	Analyst x1	Analyst x1	Est @ 16.58%	Est @ 12.68%	Est @ 9.94%	Est @ 8.03%	Est @ 6.69%
Present Value (MYR, Millions) Discounted @ 11%	-RM255	RM32.2	RM187	RM274	RM314	RM331	RM336	RM333	RM325	RM313

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM2.2b

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 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = RM876m× (1 + 3.6%) ÷ (11%– 3.6%) = RM12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM12b÷ ( 1 + 11%)¹⁰= RM4.4b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM6.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM1.1, 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.

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 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 0.909. 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 shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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, there are three essential elements you should further examine:

1. Risks: For example, we've discovered 1 warning sign for Top Glove Corporation Bhd that you should be aware of before investing here.
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.

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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.