Estimating The Intrinsic Value Of Qassim Cement Company (TADAWUL:3040)

In this article we are going to estimate the intrinsic value of Qassim Cement Company (TADAWUL:3040) 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. It may sound complicated, but actually it is quite simple!

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. 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.

See our latest analysis for Qassim Cement

The Method

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. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (SAR, Millions)	ر.س216.0m	ر.س339.5m	ر.س410.0m	ر.س413.0m	ر.س425.9m	ر.س446.6m	ر.س473.7m	ر.س506.3m	ر.س544.3m	ر.س587.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 3.13%	Est @ 4.85%	Est @ 6.06%	Est @ 6.90%	Est @ 7.49%	Est @ 7.91%
Present Value (SAR, Millions) Discounted @ 14%	ر.س189	ر.س260	ر.س274	ر.س242	ر.س218	ر.س200	ر.س185	ر.س173	ر.س163	ر.س154

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س2.1b

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 14%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.س587m× (1 + 8.9%) ÷ (14%– 8.9%) = ر.س12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س12b÷ ( 1 + 14%)¹⁰= ر.س3.1b

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.س5.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س58.4, the company appears around fair value at the time of writing. 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Qassim Cement 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 14%, which is based on a levered beta of 0.843. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Qassim Cement, there are three pertinent factors you should look at:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Qassim Cement (including 1 which is a bit concerning) .
2. Future Earnings: How does 3040'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. 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.