Estimating The Intrinsic Value Of Nama Chemicals Company (TADAWUL:2210)

Key Insights

• Nama Chemicals' estimated fair value is ر.س44.2 based on 2 Stage Free Cash Flow to Equity
• Current share price of ر.س36.9 suggests Nama Chemicals is trading close to its fair value
• Industry average of 18% suggests Nama Chemicals' peers are currently trading at a higher discount

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Nama Chemicals Company (TADAWUL:2210) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Nama Chemicals

Is Nama Chemicals Fairly Valued?

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 start off with, we need to estimate 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, 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (SAR, Millions)	ر.س80.8m	ر.س87.5m	ر.س94.8m	ر.س103.0m	ر.س111.9m	ر.س121.7m	ر.س132.3m	ر.س144.0m	ر.س156.7m	ر.س170.5m
Growth Rate Estimate Source	Est @ 8.01%	Est @ 8.27%	Est @ 8.45%	Est @ 8.58%	Est @ 8.66%	Est @ 8.73%	Est @ 8.77%	Est @ 8.80%	Est @ 8.82%	Est @ 8.84%
Present Value (SAR, Millions) Discounted @ 17%	ر.س69.3	ر.س64.4	ر.س59.9	ر.س55.8	ر.س52.1	ر.س48.6	ر.س45.3	ر.س42.3	ر.س39.5	ر.س36.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س514m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 17%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.س171m× (1 + 8.9%) ÷ (17%– 8.9%) = ر.س2.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س2.4b÷ ( 1 + 17%)¹⁰= ر.س524m

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.س1.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س36.9, the company appears about fair value at a 16% 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.

Important Assumptions

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 Nama Chemicals 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 17%, which is based on a levered beta of 1.183. 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 Nama Chemicals

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Nama Chemicals, we've put together three additional items you should consider:

1. Risks: We feel that you should assess the 2 warning signs for Nama Chemicals (1 is concerning!) we've flagged before making an investment in the company.
2. 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!
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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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.