Is Tenaga Nasional Berhad (KLSE:TENAGA) Trading At A 29% Discount?

Key Insights

• Tenaga Nasional Berhad's estimated fair value is RM19.34 based on 2 Stage Free Cash Flow to Equity
• Tenaga Nasional Berhad's RM13.72 share price signals that it might be 29% undervalued
• The RM15.69 analyst price target for TENAGA is 19% less than our estimate of fair value

How far off is Tenaga Nasional Berhad (KLSE:TENAGA) 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 their present 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 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (MYR, Millions)	RM2.51b	RM2.58b	RM5.05b	RM7.26b	RM7.60b	RM7.90b	RM8.21b	RM8.53b	RM8.86b	RM9.19b
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x1	Analyst x1	Analyst x1	Est @ 4.05%	Est @ 3.95%	Est @ 3.87%	Est @ 3.83%	Est @ 3.79%
Present Value (MYR, Millions) Discounted @ 9.1%	RM2.3k	RM2.2k	RM3.9k	RM5.1k	RM4.9k	RM4.7k	RM4.5k	RM4.2k	RM4.0k	RM3.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = RM40b

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 (3.7%) 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 9.1%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = RM9.2b× (1 + 3.7%) ÷ (9.1%– 3.7%) = RM176b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= RM176b÷ ( 1 + 9.1%)¹⁰= RM73b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is RM113b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of RM13.7, the company appears a touch undervalued at a 29% 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 Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Tenaga Nasional 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 9.1%, which is based on a levered beta of 0.909. 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.

Check out our latest analysis for Tenaga Nasional Berhad

SWOT Analysis for Tenaga Nasional Berhad

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Tenaga Nasional Berhad, we've put together three fundamental aspects you should consider:

1. Risks: Case in point, we've spotted 2 warning signs for Tenaga Nasional Berhad you should be aware of, and 1 of them is concerning.
2. Future Earnings: How does TENAGA'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.

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.