Calculation of the intrinsic value of Kim Hin Joo (Malaysia) Berhad (KLSE: KHJB)
Today we are going to review one way to estimate the intrinsic value of Kim Hin Joo (Malaysia) Berhad (KLSE: KHJB) by taking expected future cash flows and discounting them to today’s value. . The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the lingo, the math is actually pretty straightforward.
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. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Check out our latest analysis for Kim Hin Joo (Malaysia) Berhad
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (MYR, Millions)||RM10.7 million||RM10.9m||RM11.0 m||RM11.3 m||11.6 m RM||12.0 RM||RM12.3m||RM12.7 m||RM13.2m||RM13.6 m|
|Source of growth rate estimate||East @ -0.11%||Is @ 1.01%||Est @ 1.79%||East @ 2.34%||East @ 2.72%||Is @ 2.99%||Is @ 3.18%||East @ 3.31%||Is 3.4%||East @ 3.47%|
|Present value (MYR, millions) discounted at 12%||RM9.6||RM8.7||RM8.0||RM7.3||RM6.7||RM6.2||RM5.7||RM5.3||RM4.9||RM4.6|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = RM67m
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 12%.
Terminal value (TV)= FCF2030 Ã (1 + g) Ã· (r – g) = RM14m Ã (1 + 3.6%) Ã· (12% – 3.6%) = RM178m
Present value of terminal value (PVTV)= TV / (1 + r)ten= RM178m Ã· (1 + 12%)ten= RM59m
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is RM126 million. In the last step, we divide the equity value by the number of shares outstanding. From the current stock price of RM 0.3, the company appears to be roughly at fair value with a 19% discount from the current stock price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 full picture of a company’s potential performance. Since we consider Kim Hin Joo (Malaysia) Berhad as a potential shareholder, 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 12%, which is based on a leveraged beta of 1.354. 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.
To move on :
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 Kim Hin Joo (Malaysia) Berhad, we have put together three basic things you should take a closer look at:
- Risks: For example, we discovered 3 warning signs for Kim Hin Joo (Malaysia) Berhad (1 cannot be ignored!) Which you should be aware of before investing here.
- 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!
- Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
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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