Home Discount rate A look at the fair value of Fiamma Holdings Berhad (KLSE: FIAMMA)

A look at the fair value of Fiamma Holdings Berhad (KLSE: FIAMMA)

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Does Fiamma Holdings Berhad’s (KLSE: FIAMMA) share price in September reflect what it’s really worth? Today we are going to estimate the intrinsic value of the stock by estimating the future cash flows of the company and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

Check out our latest analysis for Fiamma Holdings Berhad

The model

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. 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, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (MYR, Millions) RM37.7m RM37.0m RM36.9m RM37.3m RM38.0m RM38.8m RM39.9m RM41.0m RM42.3m RM43.7m
Growth rate estimate Source Analyst x1 Analyst x1 East @ -0.14% Is 0.97% Is at 1.74% Is at 2.28% Is at 2.66% Is at 2.93% Is at 3.12% Is at 3.25%
Present value (MYR, millions) discounted at 9.5% RM34.4 RM30.9 RM28.1 RM26.0 RM24.1 RM22.5 RM21.1 RM19.9 RM18.7 RM17.6

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = RM243m

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond 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 9.5%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = RM44m × (1 + 3.6%) ÷ (9.5%–3.6%) = RM761m

Present value of terminal value (PVTV)= TV / (1 + r)ten= RM761m÷ ( 1 + 9.5%)ten= RM307m

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is RM550 million. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of RM1.1, the company appears around fair value at the time of writing. 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: FIAMMA discounted cash flow 2 September 2022

The hypotheses

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Fiamma 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 takes debt into account. In this calculation, we used 9.5%, which is based on a leveraged beta of 1.094. 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:

Although important, the DCF calculation is just one of many factors you need to assess 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. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Fiamma Holdings Berhad, we have put together three relevant aspects that you should assess:

  1. Risks: For example, we discovered 3 warning signs for Fiamma Holdings Berhad (1 cannot be ignored!) which you should be aware of before investing here.
  2. Future earnings: How does FIAMMA’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. Simply Wall St updates its DCF calculation for every Malaysian stock daily, so if you want to find the intrinsic value of any other stock, just 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.

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