Abu Dhabi Commercial Bank: Intrinsic Valuation

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Table of Contents

Introduction
Intrinsic Value
Implementing a Discounted Cash Flow Model
Working and results
Conclusions
Works Cited

Introduction

Abu Dhabi Commercial Bank (ADCB) is a bank operating in the United Arab Emirates. Abu Dhabi government owns 58 percent of the company’s stock. Private investors hold the remaining shares (“ADCB – Ownership Structure”). This paper aims to conduct an intrinsic valuation of the company using a discounted cash flow (DCF) model. It will also examine how ADCB’s intrinsic value corresponds to the market value to determine whether it is under or overvalued.

Intrinsic Value

The intrinsic value of a company can be defined as “the net present value (NPV) of the sum of all future free cash flows (FCF) the company will generate during its existence” (Karrakman). By determining the intrinsic value of ADCB, it is possible to determine how much the company’s stock is worth in case if the bank along with all of its assets is sold.

Implementing a Discounted Cash Flow Model

ADCB’s stock is currently selling at AED 7.20 per share (“Abu Dhabi Commercial Bank PJSC (ADCB: UH)”). ADCB has 5,198,267 shares outstanding with over AED 37.583 billion in market capitalization (“Abu Dhabi Commercial Bank PJSC – 2015 Annual Report” 143).

Working and results

The bank’s intrinsic value per share is determined by using DCF that requires at least four years’ historical data of free cash flow (FCF). The free cash flow of a bank is the amount left from the bank’s operating cash flow after making payments for its investment activities. It is understood that it is not possible to determine changes in net working capital for a bank (Pinto et al. 146). Therefore, a different approach is used for calculating the free cash flows of a bank. The process starts with determining the net cash flow from operating activities, which is available in the bank’s cash flow statement and subtracting the net cash flow from investing activities. The reason for adopting this method is that the selected bank provides not only commercial banking services but also investment banking services to its clients. The free cash flow of the bank is calculated using the following formula.

FCF = Net Cash Flow from Operating Activities – Net Cash Flow from Investing Activities

Table 1 provided below indicates the bank’s free cash flow for the last four years.

Table 1. Free Cash Flows of ADCB. Source: (“Abu Dhabi Commercial Bank PJSC – 2015 Annual Report” 115; “Abu Dhabi Commercial Bank PJSC – 2013 Annual Report” 74).

	2012	2013	2014	2015
	AED in ‘000s
Net cash flow from operating activities	6,436,806	-3,209,140	333,391	15,253,081
Net cash flow from investing activities	-3,071,070	-2,488,841	-241,013	572,250
Free cash flow	3,365,736	-5,697,981	92,378	14,680,831

Table 1 indicates that the bank did not have a steady level of free cash flow in the last four years. Therefore, it is not feasible to use the average growth rate for forecasting future cash flows. ADCB reported a perpetuity growth rate of 2.3% in its annual report for 2015 (“Abu Dhabi Commercial Bank PJSC – 2015 Annual Report” 115). The future FCF is calculated using the following formula.

FCF(f) = Last Reported / Forecasted Cash Flow x (1 + g%)

The future FCF for the next three years from 2016 to 2018 is calculated in Table 2 provided in the following.

Table 2. Forecasted FCF.

	2016(f)	2017(f)	2018(f)
Free cash flows	15,018,490.11	15,363,915.39	15,717,285.44

Table 2 indicates the bank’s expected FCF in 2018 will be AED 15.717 billion.

The Weighted Average Cost of Capital (WACC) of ADCB is calculated in Table 3 given below.

Table 3. Weighted Average Cost of Capital. Source: (“Abu Dhabi Commercial Bank PJSC – 2015 Annual Report” 136; “Abu Dhabi Commercial Bank PJSC (ADCB: UH)”).

Debt	D	33,471,731
Equity	E	28,732,803
Risk-free rate	Rf	1.51%
Cost of debt	Rd	1.51%
Stock beta	β	1.33
Return on market (ADSMI)	Rm	17.29%
Tax rate		0.00%
Re		22.50%
WACC		3.64%

Table 3 indicates that the cost of debt was 1.51%. The cost of debt (Rd) is calculated by dividing interest payable by the total borrowings of the bank as reported by ADCB in its annual report for 2015.

Rd = Interest Payable / Total Borrowings

Rd = 506,502 / 33,471,731

Rd = 1.51%

The risk-free rate of 1.50% is the prevailing benchmark interest rate in the United Arab Emirates (UAE). The bank’s current beta coefficient is 1.33, which implies that its stock price is highly sensitive to changes in the market value. Therefore, there is a high risk of investment in the bank’s shares. The effective tax rate applicable to the bank’s operating profit was 0% in 2015 for its domestic operations as there is no corporation tax in the UAE. The return on the market is calculated by determining the percentage change in the value of the Abu Dhabi Securities Market General Index (ADSMI: IND) in the last year.

Return on Market = Index Value (29 January 2017) – Index Value (28 January 2016) / Index Value (28 January 2016)

Return on Market = (4,586 – 3,910)/3,910 = 17.29%

The cost of equity (Re) is calculated using the following formula based on the Capital Asset Pricing Model (CAPM).

Re = Risk-Free Rate + Stock Beta x (Return on Market – Risk-Free Rate)

Re = 1.50% + 1.33 x (17.29% – 1.50%)

Re = 22.50%

The WACC is calculated using the following formula.

WACC = Debt / Firm Value x Cost of Debt x (1-Tax Rate) + Equity / Firm Value x Cost of Equity (Brigham and Ehrhardt 377).

WACC = 33,471,731/ 62,204,534 x 1.51% x (1 – 0%) + 28,732,803 / 62,204,534 x 22.50%

WACC = 11.21%

The next step is to calculate the terminal value of FCF for determining the intrinsic value of a stock. The terminal value is calculated using the following formula.

Terminal Value = Last Forecasted FCF (1+ Growth Rate) / (Weighted Average Cost of Capital – Growth Rate)

Terminal Value = 15,717,285.44 x (1 + 2.3%) (11.21% – 2.3%)

Terminal Value = AED 180,520,440.62

The present value of forecasted FCFs is determined by discounting their values using WACC as the discount rate. The reason for using WACC is that it is the rate the investors and debt holders would require this rate as the minimum return on their investment in the bank’s equity or debt instruments. Table 4 indicates the present value (PV) of forecasted FCFs and terminal value.

Table 4. Present Value of FCFs and Terminal Value.

	2016 (f)	2017 (f)	2018 (f)	Terminal Value
Discount factor	0.8992	0.8086	0.7271	0.7271
PV of free cash flows	13,504,997.9	12,423,340.9	11,428,317.2	131,259,616.2

Finally, the sum of PV is calculated and divided by the total number of diluted shares reported in 2015. The reason for using the diluted number of shares is that they represent the number of shares held by ordinary shareholders.

Sum of PV of Free Cash Flows = AED 168,616,272.26

Total Number of Shares = 5,198,267

Intrinsic Value = AED 32.44

Conclusions

The basis of determining whether a company’s stock is undervalued or overvalued is that if the intrinsic value of the stock is greater or lower than the current stock price, then the stock is undervalued or overvalued respectively. It could be noted from the analysis provided in this report that the intrinsic value of ADCB’s shares is AED 32.44 that was less than the current share price i.e. AED 7.20. In this case, it could be concluded that the ADCB’s shares are undervalued. In this case, the market could be expected to shift in a way that the stock price would increase.

The shareholders may consider this as an investment opportunity in the company’s shares as there is a significant difference in the intrinsic value and current share price of ADCB. The analysis presented in this report is supported by the increase in the share price recorded in the last year. The bank’s share price was AED 6.59 on 31 December 2015, and the share price increased by 9.20% during the last 12 months. Therefore, it could be stated that the analysis provided in this report is valid and relevant to the bank’s financial position.

Works Cited

“Abu Dhabi Commercial Bank PJSC – 2013 Annual Report.”ADCB. Web.

“Abu Dhabi Commercial Bank PJSC – 2015 Annual Report.”ADCB. Web.

“Abu Dhabi Commercial Bank PJSC (ADCB:UH).” Bloomberg, 2017. Web.

“ADCB – Ownership Structure.” ADCB, 2017. Web.

Brigham, ‎Eugene F., and Michael C. Ehrhardt. Financial Management: Theory and Practice. Cengage Learning, 2016.

Karrakman, Nick. “How to Calculated Instrinsic Value (DCF).”Value Spreadsheet. Web.

Pinto, ‎Jerald E., et al. Equity Asset Valuation. John WIley & Sons, 2010.

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