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A Look At The Fair Value Of Kobay Technology Bhd. (KLSE:KOBAY)

Today we will run through one way of estimating the intrinsic value of Kobay Technology Bhd. (KLSE:KOBAY) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Kobay Technology Bhd

The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

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Generally we assume that a dollar today is more valuable than a dollar in the future, 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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (MYR, Millions)

RM32.3m

RM71.1m

RM82.8m

RM91.8m

RM99.8m

RM106.9m

RM113.3m

RM119.4m

RM125.1m

RM130.6m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Est @ 10.86%

Est @ 8.67%

Est @ 7.13%

Est @ 6.06%

Est @ 5.31%

Est @ 4.78%

Est @ 4.41%

Present Value (MYR, Millions) Discounted @ 12%

RM29.0

RM57.1

RM59.7

RM59.3

RM57.8

RM55.5

RM52.8

RM49.8

RM46.8

RM43.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM512m

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 (3.6%) 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 12%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = RM131m× (1 + 3.6%) ÷ (12%– 3.6%) = RM1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM1.7b÷ ( 1 + 12%)10= RM568m

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 RM1.1b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of RM3.0, the company appears about fair value at a 11% 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Kobay Technology 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 12%, which is based on a levered beta of 1.039. 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 Kobay Technology Bhd

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings.

Weakness

  • Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Opportunity

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

  • Current share price is below our estimate of fair value.

Threat

  • Debt is not well covered by operating cash flow.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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 Kobay Technology Bhd, we've compiled three pertinent items you should explore:

  1. Risks: Be aware that Kobay Technology Bhd is showing 1 warning sign in our investment analysis , you should know about...

  2. Future Earnings: How does KOBAY'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.

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