KPJ Healthcare Berhad's estimated fair value is RM2.35 based on 2 Stage Free Cash Flow to Equity
Current share price of RM1.47 suggests KPJ Healthcare Berhad is potentially 37% undervalued
Analyst price target for KPJ is RM1.54 which is 34% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of KPJ Healthcare Berhad (KLSE:KPJ) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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.
View our latest analysis for KPJ Healthcare Berhad
The 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, 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)
RM369.2m
RM489.7m
RM618.0m
RM647.0m
RM686.0m
RM719.1m
RM751.0m
RM782.4m
RM813.6m
RM845.0m
Growth Rate Estimate Source
Analyst x5
Analyst x5
Analyst x1
Analyst x1
Analyst x1
Est @ 4.83%
Est @ 4.44%
Est @ 4.17%
Est @ 3.99%
Est @ 3.86%
Present Value (MYR, Millions) Discounted @ 9.3%
RM338
RM410
RM473
RM453
RM439
RM421
RM402
RM383
RM365
RM346
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM4.0b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 9.3%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM15b÷ ( 1 + 9.3%)10= RM6.2b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM10b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of RM1.5, the company appears quite undervalued at a 37% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
KLSE:KPJ Discounted Cash Flow January 7th 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. 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 KPJ Healthcare 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 9.3%, which is based on a levered beta of 0.847. 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 KPJ Healthcare Berhad
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by cash flow.
Dividends are covered by earnings and cash flows.
Weakness
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Healthcare market.
Opportunity
Annual revenue is forecast to grow faster than the Malaysian market.
Trading below our estimate of fair value by more than 20%.
Threat
Annual earnings are forecast to grow slower than the Malaysian market.
Next Steps:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. Can we work out why the company is trading at a discount to intrinsic value? For KPJ Healthcare Berhad, we've put together three additional factors you should explore:
Risks: For instance, we've identified 2 warning signs for KPJ Healthcare Berhad (1 is a bit concerning) you should be aware of.
Future Earnings: How does KPJ'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.
