Stock Analysis

Is There An Opportunity With Yanbu Cement Company's (TADAWUL:3060) 30% Undervaluation?

SASE:3060
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Key Insights

  • Yanbu Cement's estimated fair value is ر.س49.98 based on 2 Stage Free Cash Flow to Equity
  • Yanbu Cement is estimated to be 30% undervalued based on current share price of ر.س35.00
  • Analyst price target for 3060 is ر.س40.04 which is 20% below our fair value estimate

Does the March share price for Yanbu Cement Company (TADAWUL:3060) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Yanbu Cement

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (SAR, Millions) ر.س343.0m ر.س328.0m ر.س385.0m ر.س764.0m ر.س791.0m ر.س829.9m ر.س880.6m ر.س941.9m ر.س1.01b ر.س1.09b
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 4.91% Est @ 6.12% Est @ 6.96% Est @ 7.55% Est @ 7.96%
Present Value (SAR, Millions) Discounted @ 15% ر.س298 ر.س248 ر.س252 ر.س435 ر.س391 ر.س357 ر.س329 ر.س305 ر.س285 ر.س268

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س3.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (8.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 15%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ر.س1.1b× (1 + 8.9%) ÷ (15%– 8.9%) = ر.س19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ر.س19b÷ ( 1 + 15%)10= ر.س4.7b

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.س7.9b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س35.0, the company appears a touch undervalued at a 30% 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 March 2nd 2023

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 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 15%, which is based on a levered beta of 0.865. 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 Cement

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Basic Materials market.
Opportunity
  • Annual earnings are forecast to grow faster than the Saudi market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Dividends are not covered by earnings.
  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

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. 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 pertinent factors you should look at:

  1. Risks: Take risks, for example - Yanbu Cement has 2 warning signs we think you should be aware of.
  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. 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.

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.