A Look At The Intrinsic Value Of Riverstone Holdings Limited (SGX:AP4)

In this article we are going to estimate the intrinsic value of Riverstone Holdings Limited (SGX:AP4) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Riverstone Holdings

The method

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 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF (MYR, Millions)	RM250.6m	RM227.5m	RM219.9m	RM184.0m	RM199.0m	RM191.9m	RM188.2m	RM186.6m	RM186.6m	RM187.5m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x1	Analyst x1	Est @ -3.55%	Est @ -1.95%	Est @ -0.82%	Est @ -0.04%	Est @ 0.52%
Present Value (MYR, Millions) Discounted @ 5.5%	RM237	RM204	RM187	RM148	RM152	RM139	RM129	RM121	RM115	RM109

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM1.5b

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 5.5%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = RM188m× (1 + 1.8%) ÷ (5.5%– 1.8%) = RM5.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM5.1b÷ ( 1 + 5.5%)¹⁰= RM3.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM4.5b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of S$1.0, the company appears about fair value at a 0.3% 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. 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 Riverstone Holdings 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 5.5%, which is based on a levered beta of 0.882. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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. For Riverstone Holdings, there are three pertinent elements you should further research:

1. Risks: Be aware that Riverstone Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...
2. Future Earnings: How does AP4'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.