A Look At The Fair Value Of RH PetroGas Limited (SGX:T13)

Key Insights

• The projected fair value for RH PetroGas is S$0.21 based on 2 Stage Free Cash Flow to Equity
• With S$0.18 share price, RH PetroGas appears to be trading close to its estimated fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of RH PetroGas Limited (SGX:T13) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for RH PetroGas

Is RH PetroGas 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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$10.2m	US$8.99m	US$8.27m	US$7.86m	US$7.63m	US$7.53m	US$7.50m	US$7.53m	US$7.59m	US$7.69m
Growth Rate Estimate Source	Est @ -18.42%	Est @ -12.28%	Est @ -7.98%	Est @ -4.97%	Est @ -2.86%	Est @ -1.39%	Est @ -0.36%	Est @ 0.36%	Est @ 0.87%	Est @ 1.22%
Present Value ($, Millions) Discounted @ 7.4%	US$9.5	US$7.8	US$6.7	US$5.9	US$5.3	US$4.9	US$4.6	US$4.3	US$4.0	US$3.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$57m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$7.7m× (1 + 2.1%) ÷ (7.4%– 2.1%) = US$147m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$147m÷ ( 1 + 7.4%)¹⁰= US$72m

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 US$129m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of S$0.2, the company appears about fair value at a 15% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 RH PetroGas 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 7.4%, which is based on a levered beta of 1.159. 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 RH PetroGas

Looking Ahead:

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 RH PetroGas, there are three essential factors you should consider:

1. Risks: Be aware that RH PetroGas is showing 1 warning sign in our investment analysis , you should know about...
2. Future Earnings: How does T13'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 Singaporean 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.