In this article we are going to estimate the intrinsic value of Tabuk Agricultural Development Company (TADAWUL:6040) by estimating the company's 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. 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 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
What's the estimated valuation?
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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
|Levered FCF (SAR, Millions)||ر.س18.0m||ر.س24.5m||ر.س31.4m||ر.س38.4m||ر.س45.4m||ر.س52.3m||ر.س59.3m||ر.س66.5m||ر.س73.8m||ر.س81.4m|
|Growth Rate Estimate Source||Est @ 48.24%||Est @ 36.39%||Est @ 28.1%||Est @ 22.29%||Est @ 18.23%||Est @ 15.39%||Est @ 13.4%||Est @ 12%||Est @ 11.03%||Est @ 10.34%|
|Present Value (SAR, Millions) Discounted @ 15%||ر.س15.7||ر.س18.6||ر.س20.8||ر.س22.2||ر.س23.0||ر.س23.1||ر.س22.9||ر.س22.4||ر.س21.7||ر.س20.9|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س211m
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 (8.8%) 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 15%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ر.س81m× (1 + 8.8%) ÷ (15%– 8.8%) = ر.س1.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س1.5b÷ ( 1 + 15%)10= ر.س388m
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.س599m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س24.5, the company appears about fair value at a 1.3% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tabuk 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 15%, which is based on a levered beta of 0.800. 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. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Tabuk Agricultural Development, we've put together three relevant items you should further research:
- Risks: As an example, we've found 2 warning signs for Tabuk Agricultural Development (1 shouldn't be ignored!) that you need to consider before investing here.
- 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!
- Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!
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. 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.
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