Stock Analysis

National Industrialization Company's (TADAWUL:2060) Intrinsic Value Is Potentially 57% Above Its Share Price

SASE:2060
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, National Industrialization fair value estimate is ر.س20.75
  • National Industrialization is estimated to be 36% undervalued based on current share price of ر.س13.24
  • The ر.س14.48 analyst price target for 2060 is 30% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of National Industrialization Company (TADAWUL:2060) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for National Industrialization

The Calculation

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. 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) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (SAR, Millions) ر.س878.7m ر.س1.15b ر.س1.39b ر.س1.36b ر.س1.85b ر.س2.08b ر.س2.33b ر.س2.58b ر.س2.84b ر.س3.12b
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x2 Analyst x2 Analyst x1 Est @ 12.75% Est @ 11.60% Est @ 10.80% Est @ 10.23% Est @ 9.84%
Present Value (SAR, Millions) Discounted @ 18% ر.س742 ر.س821 ر.س835 ر.س691 ر.س795 ر.س757 ر.س714 ر.س668 ر.س622 ر.س578

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س7.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 18%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ر.س3.1b× (1 + 8.9%) ÷ (18%– 8.9%) = ر.س36b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س36b÷ ( 1 + 18%)10= ر.س6.7b

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.س14b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ر.س13.2, the company appears quite undervalued at a 36% discount to where the stock price trades currently. 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.

dcf
SASE:2060 Discounted Cash Flow April 5th 2023

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 National Industrialization 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 18%, which is based on a levered beta of 1.320. 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 National Industrialization

Strength
  • Debt is well covered by earnings.
Weakness
  • Earnings declined over the past year.
Opportunity
  • Annual earnings are forecast to grow faster than the Saudi market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Annual revenue is expected to decline over the next 3 years.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For National Industrialization, we've compiled three important items you should further examine:

  1. Risks: Every company has them, and we've spotted 1 warning sign for National Industrialization you should know about.
  2. Future Earnings: How does 2060'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 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!

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.

Valuation is complex, but we're helping make it simple.

Find out whether National Industrialization is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.