Is There An Opportunity With Pharmaniaga Berhad's (KLSE:PHARMA) 39% Undervaluation?
Simply Wall St
6 min read
In this article we are going to estimate the intrinsic value of Pharmaniaga Berhad (KLSE:PHARMA) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
Levered FCF (MYR, Millions)
RM47.6m
RM72.1m
RM91.9m
RM110.5m
RM127.4m
RM142.4m
RM155.6m
RM167.4m
RM178.1m
RM188.0m
Growth Rate Estimate Source
Analyst x2
Analyst x1
Est @ 27.44%
Est @ 20.28%
Est @ 15.27%
Est @ 11.76%
Est @ 9.30%
Est @ 7.58%
Est @ 6.38%
Est @ 5.54%
Present Value (MYR, Millions) Discounted @ 14%
RM41.8
RM55.7
RM62.4
RM65.9
RM66.8
RM65.6
RM63.0
RM59.6
RM55.7
RM51.7
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = RM588m
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 14%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM1.9b÷ ( 1 + 14%)10= RM524m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is RM1.1b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.5, the company appears quite undervalued at a 39% 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:PHARMA Discounted Cash Flow February 20th 2023
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Pharmaniaga 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 14%, which is based on a levered beta of 1.275. 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 Pharmaniaga Berhad
Strength
Earnings growth over the past year exceeded the industry.
Debt is well covered by earnings.
Dividend is in the top 25% of dividend payers in the market.
Weakness
No major weaknesses identified for PHARMA.
Opportunity
Annual revenue is forecast to grow faster than the Malaysian market.
Good value based on P/E ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Paying a dividend but company has no free cash flows.
Annual earnings are forecast to decline for the next 3 years.
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. 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. What is the reason for the share price sitting below the intrinsic value? For Pharmaniaga Berhad, we've put together three pertinent aspects you should further research:
Future Earnings: How does PHARMA'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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