Calculating The Intrinsic Value Of Middle East Company for Manufacturing and Producing Paper (TADAWUL:1202)

Today we will run through one way of estimating the intrinsic value of Middle East Company for Manufacturing and Producing Paper (TADAWUL:1202) 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. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Middle East Company for Manufacturing and Producing Paper

Is Middle East Company for Manufacturing and Producing Paper fairly valued?

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (SAR, Millions)	ر.س116.6m	ر.س132.2m	ر.س148.2m	ر.س164.7m	ر.س181.8m	ر.س199.9m	ر.س219.1m	ر.س239.7m	ر.س261.8m	ر.س285.6m
Growth Rate Estimate Source	Est @ 15.43%	Est @ 13.45%	Est @ 12.07%	Est @ 11.1%	Est @ 10.42%	Est @ 9.95%	Est @ 9.61%	Est @ 9.38%	Est @ 9.22%	Est @ 9.11%
Present Value (SAR, Millions) Discounted @ 19%	ر.س98.1	ر.س93.6	ر.س88.3	ر.س82.5	ر.س76.6	ر.س70.9	ر.س65.4	ر.س60.2	ر.س55.3	ر.س50.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س741m

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 (8.8%) 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 19%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ر.س286m× (1 + 8.8%) ÷ (19%– 8.8%) = ر.س3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س3.1b÷ ( 1 + 19%)¹⁰= ر.س551m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is ر.س1.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ر.س27.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Middle East Company for Manufacturing and Producing Paper 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 1.856. 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 shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Middle East Company for Manufacturing and Producing Paper, there are three further items you should assess:

1. Risks: For example, we've discovered 2 warning signs for Middle East Company for Manufacturing and Producing Paper (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
2. 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!
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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