Does this valuation of Saudi Arabia’s mobile telecommunications company (TADAWUL:7030) imply that investors are paying too much?

How far is Mobile Telecommunications Company Saudi Arabia (TADAWUL:7030) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

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.

See our latest review for Mobile Telecommunications Company Saudi Arabia

The calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over 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.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (SAR, Millions) ر.س456.0m ر.س552.0m ر.س536.0m ر.س540.3m ر.س557.8m ر.س585.5m ر.س621.6m ر.س665.1m ر.س715.5m ر.س772.8m
Growth rate estimate Source Analyst x1 Analyst x1 Analyst x1 Is at 0.8% Is at 3.25% Is at 4.96% Is at 6.16% Is at 7% Is at 7.59% East @ 8%
Present value (SAR, millions) discounted at 13% ر.س404 ر.س433 ر.س372 ر.س332 ر.س304 ر.س283 ر.س266 ر.س252 ر.س240 ر.س229

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = ر.س3.1b

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 9.0%. We discount terminal cash flows to present value at a cost of equity of 13%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ر.س773m × (1 + 9.0%) ÷ (13%– 9.0%) = ر.س21b

Present value of terminal value (PVTV)= TV / (1 + r)ten= ر.س21b÷ ( 1 + 13%)ten= ر.س6.3b

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ر.س9.4b. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of ر.س13.3, the company appears slightly overvalued at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

SASE: 7030 Discounted cash flow June 2, 2022

The hypotheses

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around with the 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 are considering Mobile Telecommunications Company Saudi Arabia 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 into account the debt. In this calculation, we used 13%, 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.

Look forward:

Valuation is only one side of the coin in terms of crafting your investment thesis, and ideally it won’t be the only piece of analysis you look at for a company. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. What is the reason why the stock price exceeds the intrinsic value? For Mobile Telecommunications Company Saudi Arabia, we’ve put together three more things you should consider in more detail:

  1. Risks: We believe that you should evaluate the 1 warning sign for Mobile Telecommunications Company Saudi Arabia we reported before investing in the company.
  2. Future earnings: How does the growth rate of 7030 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 strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

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

Sean B. Jackson