Key Insights
- Riverstone Holdings' estimated fair value is S$1.49 based on 2 Stage Free Cash Flow to Equity
- Riverstone Holdings' S$0.89 share price signals that it might be 40% undervalued
- Our fair value estimate is 81% higher than Riverstone Holdings' analyst price target of RM0.83
In this article we are going to estimate the intrinsic value of Riverstone Holdings Limited (SGX:AP4) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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 begin with, we have to get estimates of 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.
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) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (MYR, Millions) | RM183.8m | RM219.7m | RM255.0m | RM301.9m | RM332.9m | RM355.9m | RM375.3m | RM392.0m | RM406.7m | RM420.0m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ 6.91% | Est @ 5.46% | Est @ 4.45% | Est @ 3.75% | Est @ 3.25% |
Present Value (MYR, Millions) Discounted @ 6.3% | RM173 | RM194 | RM212 | RM236 | RM245 | RM246 | RM244 | RM240 | RM234 | RM227 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM2.3b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.1%) 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 6.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = RM420m× (1 + 2.1%) ÷ (6.3%– 2.1%) = RM10b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= RM10b÷ ( 1 + 6.3%)10= RM5.5b
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 RM7.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of S$0.9, the company appears quite undervalued at a 40% 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](https://usnewsfile.moomoo.com/public/MM-PersistNewsContentImage/7781/20240511/0-d8770124f2e98fb989e71d7888cd3e3e-0-f3de16e8cc7243cd35e7edb4cc8b78ff.png/big)
The 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 Riverstone Holdings 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 6.3%, which is based on a levered beta of 0.918. 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 Riverstone Holdings
- Currently debt free.
- Balance sheet summary for AP4.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.
- Annual earnings are forecast to grow faster than the Singaporean market.
- Good value based on P/E ratio and estimated fair value.
- Dividends are not covered by cash flow.
- Revenue is forecast to grow slower than 20% per year.
- See AP4's dividend history.
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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Riverstone Holdings, we've put together three further items you should look at:
- Risks: To that end, you should be aware of the 1 warning sign we've spotted with Riverstone Holdings .
- Future Earnings: How does AP4'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 SGX 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.