An Intrinsic Calculation For Qatar Gas Transport Company Limited (Nakilat) (QPSC) (DSM:QGTS) Suggests It's 34% Undervalued

Does the September share price for Qatar Gas Transport Company Limited (Nakilat) (QPSC) (DSM:QGTS) 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 their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Qatar Gas Transport Company Limited (Nakilat) (QPSC)

The Model

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 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (QAR, Millions)	ر.ق2.90b	ر.ق3.10b	ر.ق3.41b	ر.ق3.71b	ر.ق4.04b	ر.ق4.39b	ر.ق4.78b	ر.ق5.21b	ر.ق5.67b	ر.ق6.17b
Growth Rate Estimate Source	Analyst x3	Analyst x2	Analyst x1	Est @ 8.81%	Est @ 8.83%	Est @ 8.85%	Est @ 8.86%	Est @ 8.86%	Est @ 8.87%	Est @ 8.87%
Present Value (QAR, Millions) Discounted @ 18%	ر.ق2.5k	ر.ق2.2k	ر.ق2.1k	ر.ق1.9k	ر.ق1.7k	ر.ق1.6k	ر.ق1.5k	ر.ق1.4k	ر.ق1.2k	ر.ق1.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.ق17b

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. 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 8.9%. We discount the terminal cash flows to today's value at a cost of equity of 18%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.ق6.2b× (1 + 8.9%) ÷ (18%– 8.9%) = ر.ق71b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.ق71b÷ ( 1 + 18%)¹⁰= ر.ق13b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ر.ق30b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ر.ق3.6, the company appears quite good value at a 34% discount to where the stock price trades currently. 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.

The Assumptions

Now 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 Qatar Gas Transport Company Limited (Nakilat) (QPSC) 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 18%, which is based on a levered beta of 1.946. 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.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Qatar Gas Transport Company Limited (Nakilat) (QPSC), we've put together three pertinent elements you should further research:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Qatar Gas Transport Company Limited (Nakilat) (QPSC) (including 1 which makes us a bit uncomfortable) .
2. Future Earnings: How does QGTS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the DSM every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.