Calculating The Fair Value Of Minho (M) Berhad (KLSE:MINHO)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Minho (M) Berhad (KLSE:MINHO) as an investment opportunity 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Minho (M) Berhad

The model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, 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

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (MYR, Millions)	RM16.1m	RM14.5m	RM13.7m	RM13.3m	RM13.1m	RM13.2m	RM13.3m	RM13.6m	RM13.9m	RM14.3m
Growth Rate Estimate Source	Est @ -15.73%	Est @ -9.95%	Est @ -5.9%	Est @ -3.06%	Est @ -1.08%	Est @ 0.31%	Est @ 1.28%	Est @ 1.96%	Est @ 2.44%	Est @ 2.77%
Present Value (MYR, Millions) Discounted @ 13%	RM14.3	RM11.5	RM9.6	RM8.3	RM7.3	RM6.5	RM5.8	RM5.3	RM4.8	RM4.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM77m

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. 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)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = RM14m× (1 + 3.6%) ÷ (13%– 3.6%) = RM165m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM165m÷ ( 1 + 13%)¹⁰= RM51m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM128m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM0.4, the company appears around fair value at the time of writing. 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.

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Minho (M) 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 1.656. 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. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Minho (M) Berhad, we've put together three essential items you should further research:

1. Risks: For instance, we've identified 3 warning signs for Minho (M) Berhad (1 is significant) you should be aware of.
2. 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!
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. 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.