Calculating The Intrinsic Value Of ARB IOT Group Limited (NASDAQ:ARBB)

Key Insights

• The projected fair value for ARB IOT Group is US$2.77 based on 2 Stage Free Cash Flow to Equity
• With US$2.59 share price, ARB IOT Group appears to be trading close to its estimated fair value
• Peers of ARB IOT Group are currently trading on average at a 7.5% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of ARB IOT Group Limited (NASDAQ:ARBB) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for ARB IOT Group

Crunching The Numbers

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.

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 (MYR, Millions)	RM15.1m	RM18.2m	RM21.0m	RM23.4m	RM25.4m	RM27.1m	RM28.5m	RM29.8m	RM31.0m	RM32.0m
Growth Rate Estimate Source	Est @ 28.59%	Est @ 20.70%	Est @ 15.18%	Est @ 11.31%	Est @ 8.60%	Est @ 6.71%	Est @ 5.38%	Est @ 4.46%	Est @ 3.81%	Est @ 3.35%
Present Value (MYR, Millions) Discounted @ 9.2%	RM13.8	RM15.3	RM16.1	RM16.4	RM16.4	RM16.0	RM15.4	RM14.8	RM14.0	RM13.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM152m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.3%) 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 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM32m× (1 + 2.3%) ÷ (9.2%– 2.3%) = RM475m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM475m÷ ( 1 + 9.2%)¹⁰= RM197m

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 RM349m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$2.6, the company appears about fair value at a 6.4% 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. 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 ARB IOT Group 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 9.2%, which is based on a levered beta of 1.086. 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 ARB IOT Group

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. For ARB IOT Group, there are three further aspects you should consider:

1. Risks: For example, we've discovered 4 warning signs for ARB IOT Group (2 don't sit too well with us!) that you should be aware of before investing here.
2. Future Earnings: How does ARBB'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 American 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.