Stock Analysis

# Calculating The Fair Value Of Yanbu Cement Company (TADAWUL:3060)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Yanbu Cement Company (TADAWUL:3060) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Yanbu Cement

### What's the estimated valuation?

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 begin with, we have to get estimates of 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) forecast

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (SAR, Millions) ر.س346.0m ر.س340.0m ر.س345.2m ر.س358.1m ر.س377.0m ر.س401.0m ر.س429.5m ر.س462.3m ر.س499.3m ر.س540.5m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 1.53% Est @ 3.73% Est @ 5.28% Est @ 6.35% Est @ 7.11% Est @ 7.64% Est @ 8.01% Est @ 8.27% Present Value (SAR, Millions) Discounted @ 14% ر.س304 ر.س262 ر.س234 ر.س213 ر.س197 ر.س184 ر.س173 ر.س163 ر.س155 ر.س147

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س2.0b

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)= FCF2030 × (1 + g) ÷ (r – g) = ر.س541m× (1 + 8.9%) ÷ (14%– 8.9%) = ر.س12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س12b÷ ( 1 + 14%)10= ر.س3.2b

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.س5.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س37.0, the company appears around fair value at the time of writing. 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.

### The 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 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 14%, which is based on a levered beta of 0.800. 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.

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Yanbu Cement, we've compiled three pertinent items you should further examine:

1. Risks: For example, we've discovered 1 warning sign for Yanbu Cement that you should be aware of before investing here.
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 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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### Valuation is complex, but we're helping make it simple.

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This article by Simply Wall St is general in nature. 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.
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