Stock Analysis

Is There An Opportunity With Yanbu National Petrochemical Company's (TADAWUL:2290) 35% Undervaluation?

SASE:2290
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Key Insights

  • Yanbu National Petrochemical's estimated fair value is ر.س66.3 based on 2 Stage Free Cash Flow to Equity
  • Current share price of ر.س43.0 suggests Yanbu National Petrochemical is 35% undervalued
  • Analyst price target for 2290 is ر.س45.75 which is 31% below our fair value estimate

In this article we are going to estimate the intrinsic value of Yanbu National Petrochemical Company (TADAWUL:2290) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Yanbu National Petrochemical

Is Yanbu National Petrochemical 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. 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, 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) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (SAR, Millions) ر.س1.54b ر.س1.70b ر.س2.40b ر.س2.85b ر.س3.30b ر.س3.75b ر.س4.20b ر.س4.68b ر.س5.17b ر.س5.68b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x1 Est @ 18.64% Est @ 15.71% Est @ 13.66% Est @ 12.22% Est @ 11.22% Est @ 10.51% Est @ 10.02%
Present Value (SAR, Millions) Discounted @ 15% ر.س1.3k ر.س1.3k ر.س1.6k ر.س1.6k ر.س1.6k ر.س1.6k ر.س1.5k ر.س1.5k ر.س1.4k ر.س1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س15b

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 15%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ر.س5.7b× (1 + 8.9%) ÷ (15%– 8.9%) = ر.س94b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س94b÷ ( 1 + 15%)10= ر.س23b

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.س37b. 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.س43.0, the company appears quite good value at a 35% 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:2290 Discounted Cash Flow January 14th 2023

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 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 0.936. 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 Yanbu National Petrochemical

Strength
  • Currently debt free.
  • Dividend is in the top 25% of dividend payers in the market.
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
  • Dividends are not covered by earnings and cashflows.
  • Annual revenue is expected to decline over the next 4 years.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Yanbu National Petrochemical, there are three relevant elements you should further research:

  1. Risks: Case in point, we've spotted 2 warning signs for Yanbu National Petrochemical you should be aware of, and 1 of them is significant.
  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 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.

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

Find out whether Yanbu National Petrochemical 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.