Calculating The Intrinsic Value Of ARB IOT Group Limited (NASDAQ:ARBB)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, ARB IOT Group fair value estimate is US$2.77

• ARB IOT Group's US$2.59 share price indicates it is trading at similar levels as its fair value estimate

• The average premium for ARB IOT Group's competitorsis currently 7.5%

Today we will run through one way of estimating the intrinsic value of ARB IOT Group Limited (NASDAQ:ARBB) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for ARB IOT Group

The Calculation

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (MYR, Millions)	RM15.1m	RM18.2m	RM21.0m	RM23.4m	RM25.4m	RM27.1m	RM28.5m	RM29.8m	RM31.0m	RM32.0m
Growth Rate Estimate Source	Est @ 28.59%	Est @ 20.70%	Est @ 15.18%	Est @ 11.31%	Est @ 8.60%	Est @ 6.71%	Est @ 5.38%	Est @ 4.46%	Est @ 3.81%	Est @ 3.35%
Present Value (MYR, Millions) Discounted @ 9.2%	RM13.8	RM15.3	RM16.1	RM16.4	RM16.4	RM16.0	RM15.4	RM14.8	RM14.0	RM13.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM152m

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM32m× (1 + 2.3%) ÷ (9.2%– 2.3%) = RM475m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM475m÷ ( 1 + 9.2%)¹⁰= RM197m

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 RM349m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$2.6, the company appears about fair value at a 6.4% 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.

dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 ARB IOT Group 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 9.2%, which is based on a levered beta of 1.086. 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 ARB IOT Group

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

Opportunity

• Current share price is below our estimate of fair value.

Threat

• No apparent threats visible for ARBB.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For ARB IOT Group, there are three additional aspects you should look at:

1. Risks: We feel that you should assess the 4 warning signs for ARB IOT Group (2 make us uncomfortable!) we've flagged before making an investment in the company.

2. Future Earnings: How does ARBB'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 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 NASDAQCM 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.