A Look At The Intrinsic Value Of Saudi Arabian Mining Company (Ma'aden) (TADAWUL:1211)

Does the February share price for Saudi Arabian Mining Company (Ma'aden) (TADAWUL:1211) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. 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. 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 Saudi Arabian Mining Company (Ma'aden)

The calculation

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. 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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (SAR, Millions)	ر.س709.5m	ر.س1.36b	ر.س2.31b	ر.س3.10b	ر.س3.92b	ر.س4.76b	ر.س5.59b	ر.س6.43b	ر.س7.27b	ر.س8.13b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 34.1%	Est @ 26.53%	Est @ 21.23%	Est @ 17.53%	Est @ 14.93%	Est @ 13.11%	Est @ 11.84%
Present Value (SAR, Millions) Discounted @ 16%	ر.س613	ر.س1.0k	ر.س1.5k	ر.س1.7k	ر.س1.9k	ر.س2.0k	ر.س2.0k	ر.س2.0k	ر.س1.9k	ر.س1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س17b

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 16%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ر.س8.1b× (1 + 8.9%) ÷ (16%– 8.9%) = ر.س128b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س128b÷ ( 1 + 16%)¹⁰= ر.س30b

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.س46b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س41.7, 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.

The 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 Saudi Arabian Mining Company (Ma'aden) 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 1.106. 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.

Next Steps:

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. 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 Saudi Arabian Mining Company (Ma'aden), we've compiled three additional factors you should look at:

1. Financial Health: Does 1211 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 1211'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. Simply Wall St updates its DCF calculation for every Saudi stock every day, so if you want to find the intrinsic value of any other stock 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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