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# Calculating The Fair Value Of Tao Heung Holdings Limited (HKG:573)

Today we will run through one way of estimating the intrinsic value of Tao Heung Holdings Limited (HKG:573) by estimating the company's future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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### 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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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

 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Levered FCF (HK\$, Millions) HK\$131.95 HK\$119.92 HK\$112.99 HK\$109.10 HK\$107.13 HK\$106.41 HK\$106.56 HK\$107.30 HK\$108.46 HK\$109.94 Growth Rate Estimate Source Est @ -13.88% Est @ -9.11% Est @ -5.78% Est @ -3.44% Est @ -1.81% Est @ -0.67% Est @ 0.13% Est @ 0.7% Est @ 1.09% Est @ 1.36% Present Value (HK\$, Millions) Discounted @ 8.66% HK\$121.42 HK\$101.56 HK\$88.06 HK\$78.25 HK\$70.71 HK\$64.64 HK\$59.56 HK\$55.19 HK\$51.34 HK\$47.89

Present Value of 10-year Cash Flow (PVCF)= HK\$738.63m

"Est" = FCF growth rate estimated by Simply Wall St

After calculating the present value of future cash flows in the intial 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 10-year government bond rate of 2%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.

Terminal Value (TV) = FCF2029 Ã— (1 + g) Ã· (r â€“ g) = HK\$110m Ã— (1 + 2%) Ã· (8.7% â€“ 2%) = HK\$1.7b

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = HK\$HK\$1.7b Ã· ( 1 + 8.7%)10 = HK\$733.37m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK\$1.47b. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of HK\$1.45. Relative to the current share price of HK\$1.58, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

### 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 Tao Heung Holdings 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 8.7%, which is based on a levered beta of 1.002. 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.

### Next Steps:

Whilst important, DCF calculation shouldnâ€™t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Tao Heung Holdings, I've put together three pertinent factors you should look at:

1. Financial Health: Does 573 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 573? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every HK stock every day, so if you want to find the intrinsic value of any other stock just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.