Does the December share price for IOI Corporation Berhad (KLSE: IOICORP) reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. Don’t be put off by the lingo, the underlying calculations are actually pretty straightforward.

Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should read the Simply Wall St.

See our latest review for IOI Corporation Berhad

The method

We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.

Generally, we assume that a dollar today is worth more 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) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (MYR, Millions) RM1.22b RM1.11b RM1.00b RM949.1 million RM923.3m RM915.6m RM920.1m RM933.2m RM952.6 million RM976.7 million
Source of estimated growth rate Analyst x3 Analyst x4 Analyst x3 Is @ -5.43% East @ -2.73% East @ -0.83% Is @ 0.5% Est @ 1.42% East @ 2.07% Is 2.53%
Present value (MYR, millions) discounted at 7.9% RM1.1k RM954 RM799 RM700 RM631 RM580 RM540 RM508 RM480 RM457

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = RM6.8b

The second stage is also known as terminal value, it is the cash flow of the business 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 used the 5-year average of the 10-year government bond yield (3.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.9%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = RM977m × (1 + 3.6%) ÷ (7.9% – 3.6%) = RM23b

Present value of terminal value (PVTV)= TV / (1 + r)ten= RM23b ÷ (1 + 7.9%)ten= RM11b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is RM18b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of RM 3.6, the company appears to be slightly overvalued at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.

KLSE: IOICORP Discounted cash flow December 17, 2021

Important assumptions

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 full picture of a company’s potential performance. Since we consider IOI Corporation Berhad to be 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 takes debt into account. In this calculation, we used 7.9%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Move on :

While valuing a business is important, it’s just one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Why is intrinsic value lower than the current share price? For IOI Corporation Berhad, we have put together three essential factors to consider:

  1. Risks: You should be aware of the 2 warning signs for IOI Corporation Berhad (1 makes us a little uncomfortable!) We found out before considering an investment in the business.
  2. Future benefits: How does IOICORP’s growth rate compare to that of its peers and the wider market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
  3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each KLSE share. If you want to find the calculation for other actions, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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