Are Investors Undervaluing Malaysia Marine and Heavy Engineering Holdings Berhad (KLSE:MHB) By 48%?

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

Thu, Nov 9, 2023, 5:40 PM 6 min read

The projected fair value for Malaysia Marine and Heavy Engineering Holdings Berhad is RM0.94 based on 2 Stage Free Cash Flow to Equity
Current share price of RM0.48 suggests Malaysia Marine and Heavy Engineering Holdings Berhad is potentially 48% undervalued
The RM0.68 analyst price target for MHB is 28% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Malaysia Marine and Heavy Engineering Holdings Berhad (KLSE:MHB) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. 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.

View our latest analysis for Malaysia Marine and Heavy Engineering Holdings Berhad

What's The Estimated Valuation?

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM150.0m	RM176.7m	RM197.2m	RM215.3m	RM231.4m	RM246.0m	RM259.5m	RM272.3m	RM284.5m	RM296.5m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 11.60%	Est @ 9.18%	Est @ 7.49%	Est @ 6.31%	Est @ 5.48%	Est @ 4.90%	Est @ 4.50%	Est @ 4.21%
Present Value (MYR, Millions) Discounted @ 17%	RM129	RM130	RM124	RM116	RM107	RM97.4	RM88.0	RM79.1	RM70.8	RM63.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM1.0b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 17%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM296m× (1 + 3.6%) ÷ (17%– 3.6%) = RM2.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM2.3b÷ ( 1 + 17%)¹⁰= RM498m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM1.5b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.5, the company appears quite good value at a 48% 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.

dcf — KLSE:MHB Discounted Cash Flow November 10th 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. 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 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 1.929. 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

Forecast to reduce losses next year.

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

Threat

Debt is not well covered by operating cash flow.

Has less than 3 years of cash runway based on current free cash flow.

Paying a dividend but company is unprofitable.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. Can we work out why the company is trading at a discount to intrinsic value? For Malaysia Marine and Heavy Engineering Holdings Berhad, we've put together three pertinent items you should assess:

Risks: As an example, we've found 2 warning signs for Malaysia Marine and Heavy Engineering Holdings Berhad (1 doesn't sit too well with us!) that you need to consider before investing here.
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 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.