A Look At The Fair Value Of Volcano Berhad (KLSE:VOLCANO)

Key Insights

• Volcano Berhad's estimated fair value is RM0.75 based on 2 Stage Free Cash Flow to Equity

• Current share price of RM0.77 suggests Volcano Berhad is potentially trading close to its fair value

• Volcano Berhad's peers seem to be trading at a higher premium to fair value based onthe industry average of -137%

Today we will run through one way of estimating the intrinsic value of Volcano Berhad (KLSE:VOLCANO) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

View our latest analysis for Volcano Berhad

Crunching The Numbers

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (MYR, Millions)	RM7.50m	RM8.20m	RM8.82m	RM9.37m	RM9.89m	RM10.4m	RM10.8m	RM11.3m	RM11.8m	RM12.2m
Growth Rate Estimate Source	Est @ 11.68%	Est @ 9.24%	Est @ 7.54%	Est @ 6.34%	Est @ 5.50%	Est @ 4.92%	Est @ 4.51%	Est @ 4.22%	Est @ 4.02%	Est @ 3.88%
Present Value (MYR, Millions) Discounted @ 9.9%	RM6.8	RM6.8	RM6.6	RM6.4	RM6.2	RM5.9	RM5.6	RM5.3	RM5.0	RM4.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM59m

The second stage is also known as Terminal Value, this is the business's cash flow 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 have used the 5-year average of the 10-year government bond 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 9.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = RM12m× (1 + 3.6%) ÷ (9.9%– 3.6%) = RM198m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM198m÷ ( 1 + 9.9%)¹⁰= RM77m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM136m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM0.8, the company appears around fair value at the time of writing. 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

The Assumptions

Now 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 Volcano 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 accounts for debt. In this calculation we've used 9.9%, which is based on a levered beta of 1.008. 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.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Volcano Berhad, we've compiled three pertinent elements you should explore:

1. Risks: As an example, we've found 2 warning signs for Volcano Berhad that you need to consider before investing here.

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 is out there you may be missing!

3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

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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.

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