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Is There An Opportunity With Muhibbah Engineering (M) Bhd.'s (KLSE:MUHIBAH) 50% Undervaluation?

Simply Wall St
·6-min read

In this article we are going to estimate the intrinsic value of Muhibbah Engineering (M) Bhd. (KLSE:MUHIBAH) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Muhibbah Engineering (M) Bhd

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (MYR, Millions)

RM134.5m

RM138.7m

RM142.9m

RM147.5m

RM152.3m

RM157.5m

RM162.9m

RM168.5m

RM174.4m

RM180.5m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ 3.04%

Est @ 3.19%

Est @ 3.30%

Est @ 3.38%

Est @ 3.43%

Est @ 3.46%

Est @ 3.49%

Est @ 3.51%

Present Value (MYR, Millions) Discounted @ 18%

RM114

RM100

RM87.9

RM77.2

RM67.8

RM59.6

RM52.4

RM46.1

RM40.6

RM35.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM682m

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 18%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = RM181m× (1 + 3.6%) ÷ (18%– 3.6%) = RM1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM1.3b÷ ( 1 + 18%)10= RM264m

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 RM946m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM0.7, the company appears quite good value at a 50% 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

Important Assumptions

Now 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 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 18%, which is based on a levered beta of 1.824. 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

  • Net debt to equity ratio below 40%.

Weakness

  • Interest payments on debt are not well covered.

  • Shareholders have been diluted in the past year.

Opportunity

  • Expected to breakeven next year.

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

  • Good value based on P/S ratio and estimated fair value.

Threat

  • Debt is not well covered by operating cash flow.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Muhibbah Engineering (M) Bhd, we've compiled three essential factors you should further research:

  1. Risks: Case in point, we've spotted 1 warning sign for Muhibbah Engineering (M) Bhd you should be aware of.

  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 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.

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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