Stock Analysis

An Intrinsic Calculation For Yanbu National Petrochemical Company (TADAWUL:2290) Suggests It's 33% Undervalued

SASE:2290
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Today we will run through one way of estimating the intrinsic value of Yanbu National Petrochemical Company (TADAWUL:2290) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 Yanbu National Petrochemical

The model

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 start off with, we need to estimate the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (SAR, Millions) ر.س1.68b ر.س1.82b ر.س2.89b ر.س3.54b ر.س4.20b ر.س4.85b ر.س5.51b ر.س6.18b ر.س6.87b ر.س7.59b
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x1 Est @ 22.56% Est @ 18.45% Est @ 15.58% Est @ 13.57% Est @ 12.16% Est @ 11.17% Est @ 10.48%
Present Value (SAR, Millions) Discounted @ 15% ر.س1.5k ر.س1.4k ر.س1.9k ر.س2.0k ر.س2.1k ر.س2.1k ر.س2.1k ر.س2.1k ر.س2.0k ر.س1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س19b

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 15%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ر.س7.6b× (1 + 8.9%) ÷ (15%– 8.9%) = ر.س140b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س140b÷ ( 1 + 15%)10= ر.س35b

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.س54b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س64.5, the company appears quite good value at a 33% 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.

dcf
SASE:2290 Discounted Cash Flow January 7th 2021

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 Yanbu National Petrochemical 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 0.941. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Yanbu National Petrochemical, there are three important factors you should explore:

  1. Risks: As an example, we've found 2 warning signs for Yanbu National Petrochemical (1 is concerning!) that you need to consider before investing here.
  2. Future Earnings: How does 2290'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.

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