Today we are going to walk through a way to estimate the intrinsic value of Tenaga Nasional Berhad (KLSE:TENAGA) by estimating the company’s future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.

Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.

See our latest analysis for Tenaga Nasional Berhad

crush numbers

We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

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

Estimated free cash flow (FCF) over 10 years

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (MYR, Millions) RM7.56b RM8.39b RM9.07b RM5.26b RM4.85b RM4.51b RM4.34b RM4.27b RM4.27b
Growth rate estimate Source Analyst x6 Analyst x6 Analyst x6 Analyst x1 Analyst x1 East @ -11.4% Is @ -6.92% Is @ -3.78% Is @ -1.58% East @ -0.04%
Present value (MYR, millions) discounted at 7.9% RM7.0k RM7.2k RM7.2k RM3.9k RM3.7k RM3.1k RM2.7k RM2.4k RM2.2k RM2.0k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = RM41b

We now need to calculate the terminal value, which represents 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 10-year government bond yield of 3.6%. We discount the terminal cash flows to their present value at a cost of equity of 7.9%.

Terminal value (TV)= FCF × (1 + g) ÷ (r – g) = RM4.3b × (1 + 3.6%) ÷ (7.9%–3.6%) = RM102b

Present value of terminal value (PVTV)= TV / (1 + r)ten= RM102b÷ ( 1 + 7.9%)ten= RM48b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is RM89b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of RM9.1, the company appears to be pretty good value at a 42% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

KLSE: discounted cash flow TENAGA May 14, 2022

Important 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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Tenaga Nasional 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 used 7.9%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Although important, the DCF calculation is just one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Why is intrinsic value higher than the current stock price? For Tenaga Nasional Berhad, we’ve put together three more factors for you to assess:

  1. Risks: For example, we have identified 2 warning signs for Tenaga Nasional Berhad (1 is potentially serious) of which you should be aware.
  2. Future earnings: How does TENAGA’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. The Simply Wall St app performs an updated cash flow valuation for each stock on the KLSE every day. If you want to find the calculation for other stocks, search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.