Today we'll do a simple run through of a valuation method used to estimate the attractiveness of WCT Holdings Berhad (KLSE:WCT) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, 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
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (MYR, Millions)
RM134.0m
RM132.2m
RM138.5m
RM130.1m
RM126.0m
RM124.5m
RM124.8m
RM126.4m
RM128.9m
RM132.0m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Analyst x1
Est @ -6.07%
Est @ -3.18%
Est @ -1.15%
Est @ 0.26%
Est @ 1.26%
Est @ 1.95%
Est @ 2.44%
Present Value (MYR, Millions) Discounted @ 20%
RM112
RM92.4
RM81.0
RM63.6
RM51.5
RM42.6
RM35.7
RM30.2
RM25.8
RM22.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM557m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 20%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM853m÷ ( 1 + 20%)10= RM143m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM699m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.4, the company appears about fair value at a 14% 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:WCT Discounted Cash Flow March 29th 2023
Important Assumptions
Now 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 WCT Holdings 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 20%, which is based on a levered beta of 2.000. 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 WCT Holdings Berhad
Strength
Earnings growth over the past year exceeded the industry.
Weakness
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Construction market.
Opportunity
Good value based on P/E ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Annual earnings are forecast to decline for the next 3 years.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For WCT Holdings Berhad, there are three additional items you should consider:
Risks: Take risks, for example - WCT Holdings Berhad has 2 warning signs we think you should be aware of.
Future Earnings: How does WCT'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.
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