Are investors undervaluing Genting Malaysia Berhad (KLSE:GENM) by 40%?

0

Does Genting Malaysia Berhad’s (KLSE:GENM) May Share Price Reflect What It’s Really Worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. One way to do this is to use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.

Check out our latest analysis for Genting Malaysia Berhad

The method

We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (MYR, Millions) RM2.60b RM2.57b RM2.53b RM2.54b RM2.56b RM2.61b RM2.67b RM2.74b RM2.83b RM2.91b
Growth rate estimate Source Analyst x5 Analyst x5 Analyst x5 Is 0.05% Is at 1.1% Is at 1.83% Is at 2.35% Is at 2.71% Is at 2.96% Is at 3.14%
Present value (MYR, millions) discounted at 11% RM2.3k RM2.1k RM1.8k RM1.7k RM1.5k RM1.4k RM1.3k RM1.2k RM1.1k RM996

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = RM15b

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 3.6%. We discount terminal cash flows to present value at a cost of equity of 11%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = RM2.9b × (1 + 3.6%) ÷ (11%– 3.6%) = RM39b

Present value of terminal value (PVTV)= TV / (1 + r)ten= RM39b÷ ( 1 + 11%)ten= RM13b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is RM29b. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of RM3.0, the company seems to have pretty good value with a 40% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

KLSE: GENM Cash Flow Update May 22, 2022

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we are considering Genting Malaysia Berhad as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which factors in debt. In this calculation, we used 11%, which is based on a leveraged beta of 1.434. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

While valuing a business is important, ideally it won’t be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Why is the stock price below intrinsic value? For Genting Malaysia Berhad, there are three additional items you should consider in more detail:

  1. Risks: Take for example the ubiquitous specter of investment risk. We have identified 2 warning signs with Genting Malaysia Berhad, and understanding them should be part of your investment process.
  2. Future earnings: How does GENM’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs a discounted cash flow valuation for each stock on the KLSE every day. If you want to find the calculation for other stocks, search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Share.

Comments are closed.