Does the December share price for Luk Fook Holdings (International) Limited (HKG:590) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present 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. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not December 2018 then I highly recommend you check out the latest calculation for Luk Fook Holdings (International) by following the link below.
Step by step through the calculation
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. 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. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (HK$, Millions)||HK$444.00||HK$951.67||HK$1.02k||HK$957.97||HK$903.26|
|Source||Analyst x2||Analyst x3||Analyst x2||Est @ -5.71%||Est @ -5.71%|
|Present Value Discounted @ 8.97%||HK$407.45||HK$801.43||HK$785.18||HK$679.39||HK$587.85|
Present Value of 5-year Cash Flow (PVCF)= HK$3.3b
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%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = HK$903m × (1 + 2.2%) ÷ (9% – 2.2%) = HK$14b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK$14b ÷ ( 1 + 9%)5 = HK$8.9b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is HK$12b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of HK$20.68. Compared to the current share price of HK$21.35, the stock is fair value, maybe slightly overvalued at the time of writing.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Luk Fook Holdings (International) 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%, which is based on a levered beta of 0.868. 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.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For 590, I’ve put together three key factors you should further examine:
- Financial Health: Does 590 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.
- Future Earnings: How does 590’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 590? 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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.