Calculating the intrinsic value of HPMT Holdings Berhad (KLSE:HPMT)

Key findings

• The forecast fair value for HPMT Holdings Berhad is RM0.35 based on 2-step Free Cash Flow to Equity

• The current share price of RM0.35 suggests that HPMT Holdings Berhad may be trading close to its fair value

• The average premium for HPMT Holdings Berhad’s competitors is currently 114%

In this article, we will estimate the intrinsic value of HPMT Holdings Berhad (KLSE:HPMT) by taking the expected future cash flows and discounting them to today’s value. To do this, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from 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 valuation metric among many, and it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for HPMT Holdings Berhad

Step by step through the calculation

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally, the first stage is characterized by higher growth, and the second stage is characterized by lower growth. In the first stage, we need to estimate the company’s cash flows for the next ten years. 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 more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

The story goes on

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) = 56 million RM

The second period is also called the terminal value. This is the company’s cash flow after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year Treasury yield (3.6%) to estimate future growth. In the same way as with the 10-year “growth” period, we discount future cash flows to today’s value, using a cost of equity of 10%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = RM11m × (1 + 3.6%) ÷ (10% – 3.6%) = RM163m

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= RM163m÷ ( 1 + 10 %)¹⁰= 60 million RM

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is RM116 million. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of RM0.3, the company appears roughly fairly valued at a 1.1% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we are considering HPMT 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 have used 10% which is based on a levered beta of 1.087. 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.

SWOT Analysis for HPMT Holdings Berhad

Strength

weakness

Opportunity

Danger

Go on:

While the DCF calculation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued”. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For HPMT Holdings Berhad, we have put together three basic points for you to consider:

1. Risks: A typical example: We discovered 3 warning signs for HPMT Holdings Berhad You should be aware of these, and one of them is a little uncomfortable.

2. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense 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 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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