Saudi Kayan Petrochemical Company (TADAWUL:2350) Shares Could Be 49% Below Their Intrinsic Value Estimate

Key Insights

• Saudi Kayan Petrochemical's estimated fair value is ر.س25.50 based on 2 Stage Free Cash Flow to Equity
• Saudi Kayan Petrochemical is estimated to be 49% undervalued based on current share price of ر.س12.96
• The ر.س13.69 analyst price target for 2350 is 46% 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 Saudi Kayan Petrochemical Company (TADAWUL:2350) as an investment opportunity by taking the expected future cash flows and discounting them to their present 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 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Saudi Kayan Petrochemical

Step By Step Through 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. 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.

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.س1.13b	ر.س2.89b	ر.س3.56b	ر.س4.06b	ر.س4.56b	ر.س5.07b	ر.س5.61b	ر.س6.18b	ر.س6.79b	ر.س7.44b
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Est @ 13.80%	Est @ 12.35%	Est @ 11.35%	Est @ 10.64%	Est @ 10.14%	Est @ 9.80%	Est @ 9.56%
Present Value (SAR, Millions) Discounted @ 17%	ر.س965	ر.س2.1k	ر.س2.2k	ر.س2.1k	ر.س2.1k	ر.س2.0k	ر.س1.8k	ر.س1.7k	ر.س1.6k	ر.س1.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س18b

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 9.0%. 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.س7.4b× (1 + 9.0%) ÷ (17%– 9.0%) = ر.س98b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س98b÷ ( 1 + 17%)¹⁰= ر.س20b

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.س38b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س13.0, the company appears quite undervalued at a 49% 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.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Saudi Kayan 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 17%, which is based on a levered beta of 1.150. 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:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. 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 Saudi Kayan Petrochemical, we've compiled three additional factors you should further examine:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Saudi Kayan Petrochemical .
2. Future Earnings: How does 2350'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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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.