Does the February share price for Sunway Berhad (KLSE:SUNWAY) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (MYR, Millions)
-RM34.0m
-RM441.9m
RM445.0m
RM692.9m
RM970.5m
RM1.25b
RM1.52b
RM1.77b
RM1.98b
RM2.18b
Growth Rate Estimate Source
Analyst x1
Analyst x1
Analyst x1
Est @ 55.71%
Est @ 40.06%
Est @ 29.10%
Est @ 21.44%
Est @ 16.07%
Est @ 12.31%
Est @ 9.68%
Present Value (MYR, Millions) Discounted @ 12%
-RM30.4
-RM354
RM319
RM444
RM557
RM643
RM699
RM726
RM730
RM716
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM4.4b
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 (3.5%) 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 12%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM27b÷ ( 1 + 12%)10= RM9.0b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM13b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM2.7, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
KLSE:SUNWAY Discounted Cash Flow February 22nd 2024
The 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. 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 Sunway 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 12%, which is based on a levered beta of 1.293. 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 Sunway Berhad
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by earnings.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Industrials market.
Expensive based on P/E ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual revenue is forecast to grow faster than the Malaysian market.
Threat
Debt is not well covered by operating cash flow.
Dividends are not covered by cash flow.
Annual earnings are forecast to grow slower than the Malaysian market.
Next Steps:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Sunway Berhad, we've compiled three essential factors you should assess:
Risks: For example, we've discovered 4 warning signs for Sunway Berhad (1 is a bit unpleasant!) that you should be aware of before investing here.
Future Earnings: How does SUNWAY'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
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.
