Is Saudi Pharmaceutical Industries and Medical Appliances Corporation (TADAWUL:2070) Worth ر.س38.1 Based On Its Intrinsic Value?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Saudi Pharmaceutical Industries and Medical Appliances fair value estimate is ر.س28.48
• Saudi Pharmaceutical Industries and Medical Appliances' ر.س38.05 share price signals that it might be 34% overvalued
• Industry average of 218% suggests Saudi Pharmaceutical Industries and Medical Appliances' peers are currently trading at a higher premium to fair value

How far off is Saudi Pharmaceutical Industries and Medical Appliances Corporation (TADAWUL:2070) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

See our latest analysis for Saudi Pharmaceutical Industries and Medical Appliances

Is Saudi Pharmaceutical Industries and Medical Appliances Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (SAR, Millions)	ر.س43.0m	ر.س73.0m	ر.س128.0m	ر.س181.0m	ر.س240.0m	ر.س289.8m	ر.س339.7m	ر.س389.9m	ر.س440.7m	ر.س492.7m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Est @ 20.76%	Est @ 17.23%	Est @ 14.76%	Est @ 13.03%	Est @ 11.82%
Present Value (SAR, Millions) Discounted @ 15%	ر.س37.5	ر.س55.5	ر.س84.8	ر.س105	ر.س121	ر.س127	ر.س130	ر.س130	ر.س128	ر.س125

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س1.0b

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 9.0%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ر.س493m× (1 + 9.0%) ÷ (15%– 9.0%) = ر.س9.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س9.4b÷ ( 1 + 15%)¹⁰= ر.س2.4b

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.س3.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of ر.س38.1, the company appears potentially overvalued 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.

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 Pharmaceutical Industries and Medical Appliances 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 0.800. 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.

SWOT Analysis for Saudi Pharmaceutical Industries and Medical Appliances

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. What is the reason for the share price exceeding the intrinsic value? For Saudi Pharmaceutical Industries and Medical Appliances, there are three relevant elements you should further research:

1. Risks: Take risks, for example - Saudi Pharmaceutical Industries and Medical Appliances has 2 warning signs we think you should be aware of.
2. Future Earnings: How does 2070'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.

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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.