Is There An Opportunity With The National Agricultural Development Company's (TADAWUL:6010) 35% Undervaluation?

By
Simply Wall St
Published
May 15, 2022
SASE:6010
Source: Shutterstock

How far off is The National Agricultural Development Company (TADAWUL:6010) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

View our latest analysis for National Agricultural Development

The calculation

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 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.

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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (SAR, Millions) ر.س95.0m ر.س140.0m ر.س198.0m ر.س229.0m ر.س263.0m ر.س293.5m ر.س325.2m ر.س358.5m ر.س393.9m ر.س431.7m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Analyst x1 Analyst x1 Est @ 11.59% Est @ 10.8% Est @ 10.25% Est @ 9.86% Est @ 9.59%
Present Value (SAR, Millions) Discounted @ 13% ر.س84.1 ر.س110 ر.س137 ر.س141 ر.س143 ر.س141 ر.س138 ر.س135 ر.س131 ر.س127

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س1.3b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (9.0%) 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)= FCF2031 × (1 + g) ÷ (r – g) = ر.س432m× (1 + 9.0%) ÷ (13%– 9.0%) = ر.س12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س12b÷ ( 1 + 13%)10= ر.س3.5b

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.س4.8b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س30.2, the company appears quite undervalued at a 35% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
SASE:6010 Discounted Cash Flow May 15th 2022

Important assumptions

We would point out that 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 National Agricultural Development 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 0.812. 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 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. Can we work out why the company is trading at a discount to intrinsic value? For National Agricultural Development, we've put together three relevant aspects you should look at:

  1. Risks: You should be aware of the 1 warning sign for National Agricultural Development we've uncovered before considering an investment in the company.
  2. Future Earnings: How does 6010'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 SASE every day. If you want to find the calculation for other stocks just search here.

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