In this article we are going to estimate the intrinsic value of Qatar Gas Transport Company Limited (Nakilat) (QPSC) (DSM:QGTS) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Step by step through the calculation
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. 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) forecast
|Levered FCF (QAR, Millions)||ر.ق2.80b||ر.ق2.92b||ر.ق3.08b||ر.ق3.26b||ر.ق3.18b||ر.ق3.22b||ر.ق3.33b||ر.ق3.50b||ر.ق3.72b||ر.ق3.98b|
|Growth Rate Estimate Source||Analyst x4||Analyst x4||Analyst x3||Analyst x2||Analyst x1||Est @ 1.13%||Est @ 3.48%||Est @ 5.12%||Est @ 6.27%||Est @ 7.08%|
|Present Value (QAR, Millions) Discounted @ 19%||ر.ق2.4k||ر.ق2.1k||ر.ق1.9k||ر.ق1.7k||ر.ق1.4k||ر.ق1.2k||ر.ق1.0k||ر.ق899||ر.ق806||ر.ق729|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.ق14b
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 9.0%. We discount the terminal cash flows to today's value at a cost of equity of 19%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ر.ق4.0b× (1 + 9.0%) ÷ (19%– 9.0%) = ر.ق45b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.ق45b÷ ( 1 + 19%)10= ر.ق8.3b
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.ق22b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ر.ق3.6, the company appears about fair value at a 10% 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.
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 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 19%, which is based on a levered beta of 1.973. 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.
Although the valuation of a company is important, 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. 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 Qatar Gas Transport Company Limited (Nakilat) (QPSC), there are three additional aspects you should further research:
- Risks: For example, we've discovered 2 warning signs for Qatar Gas Transport Company Limited (Nakilat) (QPSC) (1 is potentially serious!) that you should be aware of before investing here.
- 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.
- 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 Qatari 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.