In this article we are going to estimate the intrinsic value of PETRONAS Gas Berhad (KLSE:PETGAS) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (MYR, Millions)
RM2.13b
RM2.15b
RM2.18b
RM2.23b
RM2.29b
RM2.35b
RM2.43b
RM2.50b
RM2.59b
RM2.67b
Growth Rate Estimate Source
Analyst x4
Analyst x4
Est @ 1.59%
Est @ 2.18%
Est @ 2.59%
Est @ 2.88%
Est @ 3.08%
Est @ 3.22%
Est @ 3.32%
Est @ 3.39%
Present Value (MYR, Millions) Discounted @ 9.0%
RM2.0k
RM1.8k
RM1.7k
RM1.6k
RM1.5k
RM1.4k
RM1.3k
RM1.3k
RM1.2k
RM1.1k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM15b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (3.6%) 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 9.0%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM51b÷ ( 1 + 9.0%)10= RM21b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM36b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM16.8, the company appears about fair value at a 8.1% 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.
KLSE:PETGAS Discounted Cash Flow October 2nd 2023
Important Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 PETRONAS Gas 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 9.0%, which is based on a levered beta of 0.800. 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 PETRONAS Gas Berhad
Strength
Debt is not viewed as a risk.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Gas Utilities market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Current share price is below our estimate of fair value.
Threat
Dividends are not covered by cash flow.
Annual earnings are forecast to grow slower than the Malaysian market.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For PETRONAS Gas Berhad, we've put together three pertinent aspects you should consider:
Future Earnings: How does PETGAS'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. Simply Wall St updates its DCF calculation for every Malaysian stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
