Singapore Telecommunications Limited (SGX: Z74), or Singtel for short, is one of the four major telcos in Singapore. At its current share price of S$3.50 right now, is the company a steal or is it way too expensive? One way to determine Singtel’s value would be to use the discounted cash flow (DCF) valuation method.
A DCF model essentially sums up all the cash a company can produce over its lifetime before discounting them back to the present value.
The popular way to estimate that amount of cash would be to first determine how fast a company can grow its free cash flows over the next 10 years. This is followed by estimating how fast the company can grow its free cash flows from the 11th year onward to perpetuity; this is known as the terminal growth rate.
However, there are issues with using a DCF model.
For instance, investors need to estimate how much cash a company can produce – in essence, that’s trying to project future cash flows and the future can be hard to predict. To counter some of those roadblocks, we can use a reverse-engineered DCF model instead. The reverse-engineered DCF model looks at a stock’s current price to determine the growth rate that the stock market is implying at that share price.
To produce a reverse-engineered DCF model for Singtel, here are some of the data required:
- Singtel’s current share price
- Singtel’s free cash flow per share generated over the last 12 months
- A discount rate
- A terminal growth rate for Singtel’s free cash flows
As mentioned earlier, Singtel’s current stock price is S$3.50. The company’s trailing free cash flow per share is S$0.22 (free cash flow of S$3.65 billion divided by a share count of 16.32 billion for its fiscal year ended 31 March 2019).
For the discount rate, we would be using a required rate of return (also known as the hurdle rate), which is set at 10%. Do note that there’s another way to look at the discount rate, but we are keeping things simple here.
Coming to the terminal growth rate, we would simply set it as the historical rate of long-term inflation, which is around 2% to 3% for Singapore. We will use 3% here.
So, to sum up what we have at the moment:
- Singtel’s current share price: S$3.50
- Singtel’s free cash flow per share generated over the last 12 months: S$0.224
- Discount rate: 10%
- Terminal growth rate for Singtel’s free cash flows: 3%
Using the figures above, our calculations show that the market expects Singtel’s free cash flow per share to grow by around 4% annually over the next 10 years.
The million-dollar question: Is Singtel undervalued?
We can then use the implied growth rates for Singtel’s free cash flow growth and compare it with our own views on the company’s ability to grow.
If you think the implied growth rates are too low for Singtel, then the company would be a bargain at its current price of S$3.50. However, if you think the implied growth rates are too ambitious, then Singtel could be an expensive stock right now.
In my view, Singtel’s shares don’t look cheap. The telco’s annualised free cash flow growth rate in the past decade was only around 1%, and to grow at 4% going forward might be challenging. Also, given the possible capital expenditure requirements to roll out the fifth-generation (5G) mobile technology network by 2020, free cash flow could be hit.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.