Calculation of the intrinsic value of Hiap Teck Venture Berhad (KLSE: HIAPTEK)
Today we’re going to review one way to estimate the intrinsic value of Hiap Teck Venture Berhad (KLSE: HIAPTEK) by projecting its future cash flows, then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. There really isn’t much to it, although it might seem quite complex.
We draw your attention to the fact that there are many ways to evaluate a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest review for Hiap Teck Venture Berhad
What is the estimated valuation?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. In the first step, we have to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF (MYR, Millions) | -RM16.0m | RM132.0 | RM68.0 | RM71.0 m | RM 73.7 million | 76.5 m RM | RM79.4 million | RM82.3m | RM85.4 million | RM88.5m |
Source of growth rate estimate | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 3.87% | East @ 3.79% | Est @ 3.74% | East @ 3.7% | East @ 3.68% | East @ 3.66% |
Present value (MYR, millions) discounted at 11% | -RM14.4 | RM106 | RM49.3 | RM46.2 | RM43.1 | RM40.2 | RM37.4 | RM34.9 | RM32.5 | RM30.2 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = RM405m
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 3.6%. We discount terminal cash flows to their present value at a cost of equity of 11%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = RM89m × (1 + 3.6%) ÷ (11% – 3.6%) = RM1.2b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= RM1.2b ÷ (1 + 11%)^{ten}= RM405m
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is RM810 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current stock price of RM 0.5, the company appears to be roughly at fair value with a 2.6% discount from the current stock price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The hypotheses
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Hiap Teck Venture Berhad 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 takes into account the debt. In this calculation, we used 11%, which is based on a leveraged beta of 1.314. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
While valuing a business is important, it’s just one of the many factors you need to assess for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Hiap Teck Venture Berhad, we have compiled three relevant factors to consider:
- Risks: Note that Hiap Teck Venture Berhad shows 3 warning signs in our investment analysis , you must know…
- Future benefits: How does HIAPTEK’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what else you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each KLSE share. If you want to find the calculation for other actions, do a search here.
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