Ranhill Utilities Berhad's (KLSE:RANHILL) Intrinsic Value Is Potentially 53% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Ranhill Utilities Berhad fair value estimate is RM2.40

• Ranhill Utilities Berhad's RM1.57 share price signals that it might be 35% undervalued

• Analyst price target for RANHILL is RM1.02 which is 57% below our fair value estimate

How far off is Ranhill Utilities Berhad (KLSE:RANHILL) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Ranhill Utilities Berhad

Step By Step Through The Calculation

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM131.0m	RM191.5m	RM187.1m	RM186.3m	RM187.7m	RM190.7m	RM194.9m	RM199.9m	RM205.7m	RM212.0m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -0.43%	Est @ 0.76%	Est @ 1.60%	Est @ 2.18%	Est @ 2.59%	Est @ 2.88%	Est @ 3.08%
Present Value (MYR, Millions) Discounted @ 8.6%	RM121	RM162	RM146	RM134	RM124	RM116	RM109	RM103	RM97.6	RM92.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM1.2b

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 3.6%. We discount the terminal cash flows to today's value at a cost of equity of 8.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM212m× (1 + 3.6%) ÷ (8.6%– 3.6%) = RM4.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM4.3b÷ ( 1 + 8.6%)¹⁰= RM1.9b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is RM3.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of RM1.6, the company appears quite good value at a 35% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The Assumptions

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 evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Ranhill Utilities 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 8.6%, which is based on a levered beta of 0.800. 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 Ranhill Utilities Berhad

Strength

• Debt is well covered by cash flow.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

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

Threat

• Annual earnings are forecast to grow slower than the Malaysian market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Ranhill Utilities Berhad, there are three additional aspects you should consider:

1. Risks: Case in point, we've spotted 2 warning signs for Ranhill Utilities Berhad you should be aware of, and 1 of them is a bit unpleasant.

2. Future Earnings: How does RANHILL'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Malaysian stock every day, so if you want to find the intrinsic value of any other stock 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.