Is There An Opportunity With Tenaga Nasional Berhad's (KLSE:TENAGA) 42% Undervaluation?

By
Simply Wall St
Published
May 14, 2022
KLSE:TENAGA
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Tenaga Nasional Berhad (KLSE:TENAGA) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Tenaga Nasional Berhad

Crunching the numbers

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 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (MYR, Millions) RM7.56b RM8.39b RM9.07b RM5.26b RM5.47b RM4.85b RM4.51b RM4.34b RM4.27b RM4.27b
Growth Rate Estimate Source Analyst x6 Analyst x6 Analyst x6 Analyst x1 Analyst x1 Est @ -11.4% Est @ -6.92% Est @ -3.78% Est @ -1.58% Est @ -0.04%
Present Value (MYR, Millions) Discounted @ 7.9% RM7.0k RM7.2k RM7.2k RM3.9k RM3.7k RM3.1k RM2.7k RM2.4k RM2.2k RM2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM41b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 7.9%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = RM4.3b× (1 + 3.6%) ÷ (7.9%– 3.6%) = RM102b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM102b÷ ( 1 + 7.9%)10= RM48b

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 RM89b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of RM9.1, the company appears quite good value at a 42% 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.

dcf
KLSE:TENAGA Discounted Cash Flow May 14th 2022

Important assumptions

Now 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 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 7.9%, which is based on a levered beta of 0.800. 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 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. 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 Tenaga Nasional Berhad, we've put together three further factors you should assess:

  1. Risks: For instance, we've identified 2 warning signs for Tenaga Nasional Berhad (1 is potentially serious) you should be aware of.
  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 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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Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.

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