Calculating The Fair Value Of Saudi Industrial Services Company (TADAWUL:2190)

In this article we are going to estimate the intrinsic value of Saudi Industrial Services Company (TADAWUL:2190) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

Check out our latest analysis for Saudi Industrial Services

The model

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (SAR, Millions)	ر.س218.0m	ر.س236.9m	ر.س257.6m	ر.س280.1m	ر.س304.7m	ر.س331.6m	ر.س360.8m	ر.س392.6m	ر.س427.3m	ر.س465.0m
Growth Rate Estimate Source	Est @ 8.62%	Est @ 8.68%	Est @ 8.73%	Est @ 8.76%	Est @ 8.79%	Est @ 8.8%	Est @ 8.81%	Est @ 8.82%	Est @ 8.83%	Est @ 8.83%
Present Value (SAR, Millions) Discounted @ 15%	ر.س190	ر.س180	ر.س171	ر.س162	ر.س153	ر.س145	ر.س138	ر.س131	ر.س124	ر.س118

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س1.5b

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 8.8%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = ر.س465m× (1 + 8.8%) ÷ (15%– 8.8%) = ر.س8.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س8.6b÷ ( 1 + 15%)¹⁰= ر.س2.2b

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.س3.7b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ر.س45.1, the company appears about fair value at a 0.2% discount to where the stock price trades currently. 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. 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 Industrial Services 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 1.090. 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 shouldn't be the only metric you look at when researching 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Saudi Industrial Services, there are three fundamental items you should explore:

1. Risks: Case in point, we've spotted 1 warning sign for Saudi Industrial Services you should be aware of.
2. Future Earnings: How does 2190'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.

If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.