Calculating The Intrinsic Value Of Tenaga Nasional Berhad (KLSE:TENAGA)

Key Insights

• The projected fair value for Tenaga Nasional Berhad is RM9.84 based on 2 Stage Free Cash Flow to Equity
• Tenaga Nasional Berhad's RM9.05 share price indicates it is trading at similar levels as its fair value estimate
• The RM10.30 analyst price target for TENAGA is 4.6% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Tenaga Nasional Berhad (KLSE:TENAGA) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Tenaga Nasional Berhad

What's The Estimated Valuation?

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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM11.1b	RM11.2b	RM3.48b	RM5.95b	RM4.79b	RM4.19b	RM3.87b	RM3.70b	RM3.63b	RM3.62b
Growth Rate Estimate Source	Analyst x5	Analyst x4	Analyst x1	Analyst x1	Est @ -19.46%	Est @ -12.55%	Est @ -7.72%	Est @ -4.33%	Est @ -1.96%	Est @ -0.30%
Present Value (MYR, Millions) Discounted @ 11%	RM10.1k	RM9.1k	RM2.6k	RM4.0k	RM2.9k	RM2.3k	RM1.9k	RM1.7k	RM1.5k	RM1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM37b

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)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM3.6b× (1 + 3.6%) ÷ (11%– 3.6%) = RM54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM54b÷ ( 1 + 11%)¹⁰= RM20b

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 RM57b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of RM9.1, the company appears about fair value at a 8.1% 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

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 Tenaga Nasional 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 11%, which is based on a levered beta of 0.873. 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 Tenaga Nasional Berhad

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. 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. 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 Tenaga Nasional Berhad, there are three essential items you should consider:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Tenaga Nasional Berhad (including 1 which is a bit concerning) .
2. Future Earnings: How does TENAGA'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. 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.