Calculating The Fair Value Of Favelle Favco Berhad (KLSE:FAVCO)

editorial-team@simplywallst.com (Simply Wall St)

Tue, Oct 31, 2023, 7:36 PM 6 min read

Today we will run through one way of estimating the intrinsic value of Favelle Favco Berhad (KLSE:FAVCO) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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.

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.

View our latest analysis for Favelle Favco Berhad

The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM44.1m	RM71.7m	RM57.9m	RM50.7m	RM46.8m	RM44.8m	RM44.0m	RM43.8m	RM44.2m	RM44.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -19.27%	Est @ -12.43%	Est @ -7.63%	Est @ -4.28%	Est @ -1.93%	Est @ -0.29%	Est @ 0.86%	Est @ 1.67%
Present Value (MYR, Millions) Discounted @ 11%	RM39.6	RM57.9	RM42.0	RM33.1	RM27.5	RM23.6	RM20.8	RM18.7	RM16.9	RM15.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM296m

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 3.6%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM45m× (1 + 3.6%) ÷ (11%– 3.6%) = RM605m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM605m÷ ( 1 + 11%)¹⁰= RM208m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM504m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM1.7, the company appears about fair value at a 20% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf — KLSE:FAVCO Discounted Cash Flow November 1st 2023

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Favelle Favco 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 accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 1.128. 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 Favelle Favco Berhad

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Dividend is in the top 25% of dividend payers in the market.

Weakness

No major weaknesses identified for FAVCO.

Opportunity

Annual earnings are forecast to grow faster than the Malaysian market.

Good value based on P/E ratio and estimated fair value.

Threat

Dividends are not covered by cash flow.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Favelle Favco Berhad, we've compiled three fundamental factors you should consider:

Risks: For instance, we've identified 2 warning signs for Favelle Favco Berhad that you should be aware of.
Future Earnings: How does FAVCO'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.
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the KLSE every day. If you want to find the calculation for other stocks 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.