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A Look At The Intrinsic Value Of Wharf Real Estate Investment Company Limited (HKG:1997)

Does the share price for Wharf Real Estate Investment Company Limited (HKG:1997) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the expected future cash flows and discounting them to today’s value. I will use the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! 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. Please also note that this article was written in September 2018 so be sure check out the updated calculation by following the link below.

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. To start off with we need to estimate the next five years of cash flows. 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

 2019 2020 2021 2022 2023 Levered FCF (HK\$, Millions) HK\$9.10k HK\$9.80k HK\$10.26k HK\$10.75k HK\$11.26k Source Analyst x4 Analyst x3 Est @ 4.75% Est @ 4.75% Est @ 4.75% Present Value Discounted @ 9% HK\$8.35k HK\$8.25k HK\$7.93k HK\$7.62k HK\$7.32k

Present Value of 5-year Cash Flow (PVCF)= HK\$39.46b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.2%. We discount this to today’s value at a cost of equity of 9%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = HK\$11.26b × (1 + 2.2%) ÷ (9% – 2.2%) = HK\$169.37b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK\$169.37b ÷ ( 1 + 9%)5 = HK\$110.09b

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\$149.55b. 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 of HK\$49.26. Relative to the current share price of HK\$51.9, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.

The assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Wharf Real Estate Investment 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 0.871. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For 1997, I’ve compiled three key factors you should further research:

1. Financial Health: Does 1997 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 1997’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 1997? 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 editorial-team@simplywallst.com.