Farm Fresh Berhad (KLSE:FFB) Shares Could Be 22% Below Their Intrinsic Value Estimate
Using the 2 Stage Free Cash Flow to Equity, Farm Fresh Berhad fair value estimate is RM2.35
Current share price of RM1.84 suggests Farm Fresh Berhad is potentially 22% undervalued
Our fair value estimate is 15% higher than Farm Fresh Berhad's analyst price target of RM2.04
Does the June share price for Farm Fresh Berhad (KLSE:FFB) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
We've found 21 US stocks that are forecast to pay a dividend yield of over 6% next year. See the full list for free.
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, and so the sum of these future cash flows is then discounted to today's value:
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (MYR, Millions)
RM41.4m
RM48.5m
RM95.3m
RM144.6m
RM184.3m
RM221.8m
RM255.8m
RM286.1m
RM312.8m
RM336.8m
Growth Rate Estimate Source
Analyst x4
Analyst x2
Analyst x4
Analyst x2
Est @ 27.49%
Est @ 20.33%
Est @ 15.32%
Est @ 11.82%
Est @ 9.37%
Est @ 7.65%
Present Value (MYR, Millions) Discounted @ 8.4%
RM38.2
RM41.2
RM74.9
RM105
RM123
RM137
RM146
RM150
RM152
RM151
("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = RM1.1b
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 8.4%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = RM337m× (1 + 3.6%) ÷ (8.4%– 3.6%) = RM7.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM7.4b÷ ( 1 + 8.4%)10= RM3.3b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM4.4b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of RM1.8, the company appears a touch undervalued at a 22% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Farm Fresh 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 8.4%, 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.
See our latest analysis for Farm Fresh Berhad
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Food market.
Opportunity
Annual earnings are forecast to grow faster than the Malaysian market.
Trading below our estimate of fair value by more than 20%.
Threat
Revenue is forecast to grow slower than 20% per year.
Whilst important, the DCF calculation 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. 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. Why is the intrinsic value higher than the current share price? For Farm Fresh Berhad, there are three fundamental aspects you should consider:
Financial Health: Does FFB have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does FFB'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.
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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