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Muhibbah Engineering (M) Bhd. (KLSE:MUHIBAH) Shares Could Be 27% Below Their Intrinsic Value Estimate

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Muhibbah Engineering (M) Bhd fair value estimate is RM1.29

  • Muhibbah Engineering (M) Bhd's RM0.95 share price signals that it might be 27% undervalued

  • Muhibbah Engineering (M) Bhd's peers are currently trading at a premium of 182% on average

Does the April share price for Muhibbah Engineering (M) Bhd. (KLSE:MUHIBAH) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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Check out our latest analysis for Muhibbah Engineering (M) Bhd

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (MYR, Millions)

RM19.6m

RM114.3m

RM130.3m

RM126.6m

RM125.4m

RM125.9m

RM127.5m

RM130.1m

RM133.3m

RM137.0m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Est @ -2.87%

Est @ -0.95%

Est @ 0.40%

Est @ 1.34%

Est @ 2.00%

Est @ 2.46%

Est @ 2.79%

Present Value (MYR, Millions) Discounted @ 14%

RM17.2

RM88.1

RM88.2

RM75.2

RM65.4

RM57.6

RM51.2

RM45.9

RM41.3

RM37.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM567m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 have used the 5-year average of the 10-year government bond yield (3.5%) 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 14%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = RM137m× (1 + 3.5%) ÷ (14%– 3.5%) = RM1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM1.4b÷ ( 1 + 14%)10= RM372m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM939m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.9, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

The Assumptions

We would point out that the most important 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 redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Muhibbah Engineering (M) Bhd 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 accounts for debt. In this calculation we've used 14%, which is based on a levered beta of 1.634. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Muhibbah Engineering (M) Bhd

Strength

  • Debt is well covered by cash flow.

Weakness

  • Interest payments on debt are not well covered.

Opportunity

  • Expected to breakeven next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • No apparent threats visible for MUHIBAH.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Muhibbah Engineering (M) Bhd, we've put together three essential elements you should look at:

  1. Financial Health: Does MUHIBAH have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Future Earnings: How does MUHIBAH's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. 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 is out there you may be missing!

PS. The Simply Wall St app conducts 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.