A look at the fair value of LFE Corporation Berhad (KLSE:LFECORP)

Key findings

• Using the 2-step free cash flow to equity, the fair value estimate of LFE Corporation Berhad is RM0.41

• LFE Corporation Berhad’s share price at RM0.33 suggests that the price is trading at a similar level to the estimated fair value.

• LFE Corporation Berhad’s competitors are currently trading at an average premium of 22,145%.

In this article, we will estimate the intrinsic value of LFE Corporation Berhad (KLSE:LFECORP) by taking the company’s forecasted future cash flows and discounting them to today’s value. One way to do this is by applying the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for LFE Corporation Berhad

The method

We use the 2-stage growth model, which simply means we consider two stages of company growth. In the early stage, the company may have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

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

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 183 million RM

The story goes on

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 3.6%. We discount the terminal cash flows to today’s value using a cost of equity of 10%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = RM45m× (1 + 3.6%) ÷ (10%– 3.6%) = RM711m

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= RM711m÷ ( 1 + 10 %)¹⁰= 273 million RM

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is RM456 million. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of RM0.3, the company appears roughly fairly valued at a 20% discount to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

The assumptions

The above calculation heavily depends on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we are considering LFE Corporation Berhad as prospective 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 have used 10% which is based on a levered beta of 1.025. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0 which is a reasonable range for a stable company.

Next Steps:

While important, the DCF calculation is just one of many factors you need to evaluate a company. DCF models are not the be-all and end-all of investment valuation. Rather, they should be viewed as a guide to “what assumptions need to hold 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 significantly, the outcome may look very different. For LFE Corporation Berhad, there are three additional aspects you should examine:

1. Risks: For this purpose, you should be aware of the 2 warning signs We have spotted some at LFE Corporation Berhad (including 1 that is a bit unpleasant).

2. 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 you might be missing out on!

3. More top analyst tips: Want to know what the analysts think? Take a look at our interactive list of analyst recommended stocks and find out which stocks they think could have attractive future prospects!

PS The Simply Wall St app runs 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.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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