Estimating The Fair Value Of Mesaieed Petrochemical Holding Company Q.P.S.C. (DSM:MPHC)

Does the July share price for Mesaieed Petrochemical Holding Company Q.P.S.C. (DSM:MPHC) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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 Mesaieed Petrochemical Holding Company Q.P.S.C

Crunching the numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (QAR, Millions)	ر.ق1.64b	ر.ق1.60b	ر.ق1.62b	ر.ق1.67b	ر.ق1.76b	ر.ق1.87b	ر.ق2.00b	ر.ق2.15b	ر.ق2.32b	ر.ق2.51b
Growth Rate Estimate Source	Analyst x1	Est @ -2.32%	Est @ 1.04%	Est @ 3.39%	Est @ 5.04%	Est @ 6.19%	Est @ 7%	Est @ 7.56%	Est @ 7.96%	Est @ 8.23%
Present Value (QAR, Millions) Discounted @ 13%	ر.ق1.4k	ر.ق1.2k	ر.ق1.1k	ر.ق1.0k	ر.ق937	ر.ق878	ر.ق829	ر.ق786	ر.ق748	ر.ق714

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.ق9.7b

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 (8.9%) 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)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.ق2.5b× (1 + 8.9%) ÷ (13%– 8.9%) = ر.ق61b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.ق61b÷ ( 1 + 13%)¹⁰= ر.ق17b

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.ق27b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ر.ق2.6, 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. 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 Mesaieed Petrochemical Holding Company Q.P.S.C 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 0.930. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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 Mesaieed Petrochemical Holding Company Q.P.S.C, there are three fundamental factors you should further research:

1. Risks: You should be aware of the 1 warning sign for Mesaieed Petrochemical Holding Company Q.P.S.C we've uncovered before considering an investment in the company.
2. Future Earnings: How does MPHC'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.

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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.