Is Lee Swee Kiat Group Berhad (KLSE:LEESK) Trading At A 38% Discount?

Key Insights

• Lee Swee Kiat Group Berhad’s estimated fair value is RM1.2 based on 2 Stage Free Cash Flow to Equity
• Current share price of RM0.7 suggests Lee Swee Kiat Group Berhad is 38% undervalued
• Analyst price target for LEESK is RM0.97 which is 16% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Lee Swee Kiat Group Berhad (KLSE:LEESK) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Lee Swee Kiat Group Berhad

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (MYR, Millions)	RM14.2m	RM17.3m	RM17.1m	RM17.3m	RM17.5m	RM17.9m	RM18.3m	RM18.9m	RM19.4m	RM20.1m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -0.60%	Est @ 0.64%	Est @ 1.52%	Est @ 2.13%	Est @ 2.55%	Est @ 2.85%	Est @ 3.06%	Est @ 3.21%
Present Value (MYR, Millions) Discounted @ 12%	RM12.7	RM13.8	RM12.3	RM11.1	RM10.1	RM9.3	RM8.5	RM7.8	RM7.2	RM6.7

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM100m

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) = RM20m× (1 + 3.6%) ÷ (12%– 3.6%) = RM258m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM258m÷ ( 1 + 12%)¹⁰= RM86m

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 RM186m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of RM0.7, the company appears quite undervalued at a 38% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Lee Swee Kiat Group 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 12%, which is based on a levered beta of 1.132. 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 Lee Swee Kiat Group Berhad

Next Steps:

Whilst important, the DCF calculation shouldn’t be the only metric you look at when researching 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. What is the reason for the share price sitting below the intrinsic value? For Lee Swee Kiat Group Berhad, we’ve compiled three pertinent items you should further examine:

1. Risks: To that end, you should be aware of the 2 warning signs we’ve spotted with Lee Swee Kiat Group Berhad .
2. Future Earnings: How does LEESK’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. 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.

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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.