An Intrinsic Calculation For Telekom Malaysia Berhad (KLSE:TM) Suggests It's 26% Undervalued

Key Insights

• Telekom Malaysia Berhad's estimated fair value is RM6.79 based on 2 Stage Free Cash Flow to Equity

• Telekom Malaysia Berhad's RM5.02 share price signals that it might be 26% undervalued

• Our fair value estimate is 8.4% higher than Telekom Malaysia Berhad's analyst price target of RM6.26

How far off is Telekom Malaysia Berhad (KLSE:TM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Telekom Malaysia Berhad

The Model

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 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, 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)	RM1.91b	RM2.20b	RM1.93b	RM1.79b	RM1.71b	RM1.68b	RM1.68b	RM1.70b	RM1.73b	RM1.77b
Growth Rate Estimate Source	Analyst x5	Analyst x4	Analyst x1	Est @ -7.30%	Est @ -4.04%	Est @ -1.77%	Est @ -0.17%	Est @ 0.95%	Est @ 1.73%	Est @ 2.27%
Present Value (MYR, Millions) Discounted @ 9.0%	RM1.8k	RM1.8k	RM1.5k	RM1.3k	RM1.1k	RM1.0k	RM919	RM851	RM795	RM746

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM12b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 3.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = RM1.8b× (1 + 3.6%) ÷ (9.0%– 3.6%) = RM34b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM34b÷ ( 1 + 9.0%)¹⁰= RM14b

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 RM26b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of RM5.0, the company appears a touch undervalued at a 26% 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

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Telekom Malaysia 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 9.0%, 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.

SWOT Analysis for Telekom Malaysia Berhad

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Debt is not viewed as a risk.

Weakness

• Earnings growth over the past year underperformed the Telecom industry.

• Dividend is low compared to the top 25% of dividend payers in the Telecom market.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

• Good value based on P/E ratio and estimated fair value.

Threat

• Dividends are not covered by cash flow.

• Annual earnings are forecast to grow slower than the Malaysian market.

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Telekom Malaysia Berhad, we've put together three essential aspects you should consider:

1. Risks: Case in point, we've spotted 1 warning sign for Telekom Malaysia Berhad you should be aware of.

2. Future Earnings: How does TM'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 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.