How far off is Malaysia Marine and Heavy Engineering Holdings Berhad (KLSE:MHB) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (MYR, Millions)
RM90.3m
RM150.0m
RM176.7m
RM197.2m
RM215.3m
RM231.5m
RM246.1m
RM259.7m
RM272.5m
RM284.8m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Analyst x1
Est @ 11.60%
Est @ 9.19%
Est @ 7.51%
Est @ 6.33%
Est @ 5.50%
Est @ 4.92%
Est @ 4.52%
Present Value (MYR, Millions) Discounted @ 17%
RM77.4
RM110
RM111
RM107
RM99.7
RM91.9
RM83.8
RM75.8
RM68.2
RM61.1
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM886m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 17%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM2.3b÷ ( 1 + 17%)10= RM484m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM1.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of RM0.5, the company appears quite undervalued at a 38% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
KLSE:MHB Discounted Cash Flow June 1st 2023
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Malaysia Marine and Heavy Engineering 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 17%, which is based on a levered beta of 1.632. 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 Malaysia Marine and Heavy Engineering Holdings Berhad
Strength
Debt is well covered by earnings.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Energy Services market.
Opportunity
Annual earnings are forecast to grow faster than the Malaysian market.
Trading below our estimate of fair value by more than 20%.
Threat
Debt is not well covered by operating cash flow.
Paying a dividend but company has no free cash flows.
Revenue is forecast to grow slower than 20% per year.
Moving On:
Although the valuation of a company is important, 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Malaysia Marine and Heavy Engineering Holdings Berhad, we've compiled three relevant factors you should look at:
Future Earnings: How does MHB'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.
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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