Estimating The Intrinsic Value Of Saudi Parts Center Company (TADAWUL:9533)

Key Insights

• Saudi Parts Center's estimated fair value is ر.س89.3 based on 2 Stage Free Cash Flow to Equity
• Current share price of ر.س82.0 suggests Saudi Parts Center is trading close to its fair value
• Saudi Parts Center's peers are currently trading at a premium of 2,637% on average

Today we will run through one way of estimating the intrinsic value of Saudi Parts Center Company (TADAWUL:9533) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Saudi Parts Center

The Model

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (SAR, Millions)	ر.س12.2m	ر.س15.2m	ر.س18.3m	ر.س21.3m	ر.س24.4m	ر.س27.5m	ر.س30.7m	ر.س34.0m	ر.س37.5m	ر.س41.2m
Growth Rate Estimate Source	Est @ 31.96%	Est @ 25.04%	Est @ 20.19%	Est @ 16.79%	Est @ 14.41%	Est @ 12.75%	Est @ 11.59%	Est @ 10.77%	Est @ 10.20%	Est @ 9.80%
Present Value (SAR, Millions) Discounted @ 16%	ر.س10.5	ر.س11.4	ر.س11.8	ر.س12.0	ر.س11.8	ر.س11.5	ر.س11.2	ر.س10.7	ر.س10.2	ر.س9.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س111m

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 8.9%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.س41m× (1 + 8.9%) ÷ (16%– 8.9%) = ر.س668m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س668m÷ ( 1 + 16%)¹⁰= ر.س157m

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.س268m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س82.0, the company appears about fair value at a 8.2% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Saudi Parts Center 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 16%, which is based on a levered beta of 1.035. 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 Saudi Parts Center

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Saudi Parts Center, there are three pertinent factors you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Saudi Parts Center (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SASE 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.