A Look At The Fair Value Of National Gas & Industerialization Co. (TADAWUL:2080)

Today we will run through one way of estimating the intrinsic value of National Gas & Industerialization Co. (TADAWUL:2080) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for National Gas & Industerialization

Is National Gas & Industerialization fairly valued?

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (SAR, Millions)	ر.س118.1m	ر.س121.2m	ر.س126.7m	ر.س134.1m	ر.س143.1m	ر.س153.7m	ر.س165.7m	ر.س179.2m	ر.س194.1m	ر.س210.7m
Growth Rate Estimate Source	Est @ -0.03%	Est @ 2.64%	Est @ 4.51%	Est @ 5.82%	Est @ 6.73%	Est @ 7.37%	Est @ 7.82%	Est @ 8.14%	Est @ 8.36%	Est @ 8.51%
Present Value (SAR, Millions) Discounted @ 14%	ر.س104	ر.س93.5	ر.س85.8	ر.س79.7	ر.س74.7	ر.س70.5	ر.س66.7	ر.س63.3	ر.س60.3	ر.س57.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ر.س755m

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 14%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ر.س211m× (1 + 8.9%) ÷ (14%– 8.9%) = ر.س4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ر.س4.6b÷ ( 1 + 14%)¹⁰= ر.س1.2b

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.س2.0b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س30.5, 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.

Important 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 National Gas & Industerialization 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.

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. 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. 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. For National Gas & Industerialization, we've put together three relevant elements you should further examine:

1. Risks: For example, we've discovered 2 warning signs for National Gas & Industerialization (1 shouldn't be ignored!) that you should be aware of before investing here.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.

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