Are Investors Undervaluing Malayan Cement Berhad (KLSE:MCEMENT) By 38%?

Key Insights

• Malayan Cement Berhad's estimated fair value is RM5.17 based on 2 Stage Free Cash Flow to Equity
• Current share price of RM3.20 suggests Malayan Cement Berhad is potentially 38% undervalued
• Our fair value estimate is 42% higher than Malayan Cement Berhad's analyst price target of RM3.65

Today we will run through one way of estimating the intrinsic value of Malayan Cement Berhad (KLSE:MCEMENT) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for Malayan Cement Berhad

Crunching The Numbers

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 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM705.4m	RM700.6m	RM705.0m	RM715.6m	RM730.9m	RM749.6m	RM771.1m	RM794.8m	RM820.4m	RM847.7m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 0.63%	Est @ 1.51%	Est @ 2.13%	Est @ 2.56%	Est @ 2.86%	Est @ 3.08%	Est @ 3.22%	Est @ 3.33%
Present Value (MYR, Millions) Discounted @ 13%	RM624	RM549	RM489	RM439	RM397	RM361	RM328	RM300	RM274	RM250

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM4.0b

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 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM848m× (1 + 3.6%) ÷ (13%– 3.6%) = RM9.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM9.3b÷ ( 1 + 13%)¹⁰= RM2.8b

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 RM6.8b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM3.2, the company appears quite good value at a 38% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Malayan Cement 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 13%, which is based on a levered beta of 1.173. 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.

SWOT Analysis for Malayan Cement Berhad

Moving On:

Although the valuation of a company is important, 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. Why is the intrinsic value higher than the current share price? For Malayan Cement Berhad, there are three essential elements you should assess:

1. Risks: For example, we've discovered 1 warning sign for Malayan Cement Berhad that you should be aware of before investing here.
2. Future Earnings: How does MCEMENT'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.