Stock Analysis

An Intrinsic Calculation For Yanbu Cement Company (TADAWUL:3060) Suggests It's 49% Undervalued

SASE:3060
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How far off is Yanbu Cement Company (TADAWUL:3060) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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

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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (SAR, Millions) ر.س289.0m ر.س414.0m ر.س349.0m ر.س495.0m ر.س652.0m ر.س751.7m ر.س852.3m ر.س955.1m ر.س1.06b ر.س1.17b
Growth Rate Estimate Source Analyst x1 Analyst x2 Analyst x1 Analyst x1 Analyst x1 Est @ 15.29% Est @ 13.39% Est @ 12.06% Est @ 11.13% Est @ 10.48%
Present Value (SAR, Millions) Discounted @ 13% ر.س256 ر.س324 ر.س242 ر.س304 ر.س355 ر.س362 ر.س363 ر.س360 ر.س354 ر.س347

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س3.3b

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 9.0%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ر.س1.2b× (1 + 9.0%) ÷ (13%– 9.0%) = ر.س32b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س32b÷ ( 1 + 13%)10= ر.س9.4b

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.س13b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س41.0, the company appears quite undervalued at a 49% 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:3060 Discounted Cash Flow May 16th 2022

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Yanbu 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 13%, which is based on a levered beta of 0.810. 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.

Moving On:

Although the valuation of a company is important, 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Cement, we've compiled three essential aspects you should look at:

  1. Risks: You should be aware of the 3 warning signs for Yanbu Cement (1 is a bit unpleasant!) we've uncovered before considering an investment in the company.
  2. Future Earnings: How does 3060'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 Cement 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.