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An Intrinsic Calculation For China Unicom (Hong Kong) Limited (HKG:762) Shows It’s 23.22% Undervalued

Kevin Zeng

How far off is China Unicom (Hong Kong) Limited (HKG:762) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for China Unicom (Hong Kong) by following the link below. Check out our latest analysis for China Unicom (Hong Kong)

Crunching the numbers

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 five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

2018 2019 2020 2021 2022
Levered FCF (CN¥, Millions) CN¥33.12k CN¥31.27k CN¥18.18k CN¥24.44k CN¥23.56k
Source Analyst x9 Analyst x14 Analyst x6 Analyst x1 Analyst x2
Present Value Discounted @ 9.23% CN¥30.32k CN¥26.21k CN¥13.95k CN¥17.17k CN¥15.16k

Present Value of 5-year Cash Flow (PVCF)= HK$102.81b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 9.2%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = HK$23.56b × (1 + 2.2%) ÷ (9.2% – 2.2%) = HK$342.96b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK$342.96b ÷ ( 1 + 9.2%)5 = HK$220.61b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is HK$323.42b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value in the company’s reported currency of CN¥10.57. However, 762’s primary listing is in Hong Kong, and 1 share of 762 in CNY represents 1.213 ( CNY/ HKD) share of NYSE:CHU, so the intrinsic value per share in HKD is HK$12.82. Relative to the current share price of HK$9.84, the stock is about right, perhaps slightly undervalued at a 23.22% discount to what it is available for right now.

SEHK:762 Intrinsic Value June 25th 18

Important 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at China Unicom (Hong Kong) as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.2%, which is based on a levered beta of 0.901. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 762, I’ve compiled three relevant aspects you should look at:

  1. Financial Health: Does 762 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. Future Earnings: How does 762’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: Are there other high quality stocks you could be holding instead of 762? 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 does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.