Stock Analysis

UMS Holdings Limited (SGX:558) Shares Could Be 35% Below Their Intrinsic Value Estimate

In this article we are going to estimate the intrinsic value of UMS Holdings Limited (SGX:558) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for UMS Holdings

What's the estimated valuation?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (SGD, Millions) S\$38.0m S\$67.5m S\$67.8m S\$68.3m S\$69.1m S\$70.0m S\$71.1m S\$72.2m S\$73.4m S\$74.7m Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Est @ 0.8% Est @ 1.12% Est @ 1.35% Est @ 1.5% Est @ 1.61% Est @ 1.69% Est @ 1.74% Present Value (SGD, Millions) Discounted @ 7.2% S\$35.4 S\$58.8 S\$55.0 S\$51.8 S\$48.8 S\$46.2 S\$43.7 S\$41.5 S\$39.3 S\$37.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S\$457m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = S\$75m× (1 + 1.9%) ÷ (7.2%– 1.9%) = S\$1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S\$1.4b÷ ( 1 + 7.2%)10= S\$717m

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 S\$1.2b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of S\$1.4, the company appears quite good value at a 35% 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.

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 UMS 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 7.2%, which is based on a levered beta of 1.125. 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 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For UMS Holdings, we've put together three further aspects you should look at:

1. Risks: Case in point, we've spotted 3 warning signs for UMS Holdings you should be aware of.
2. Future Earnings: How does 558'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SGX every day. If you want to find the calculation for other stocks just search here.

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