I am going to run you through how I calculated the intrinsic value of China Resources Cement Holdings Limited (HKG:1313) 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. 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 November 2018 then I highly recommend you check out the latest calculation for China Resources Cement Holdings by following the link below.
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. To begin with we have to get estimates of 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 estimate
|Levered FCF (HK$, Millions)||HK$8.01k||HK$8.41k||HK$8.50k||HK$8.59k||HK$8.68k|
|Source||Analyst x4||Analyst x4||Est @ 1.04%||Est @ 1.04%||Est @ 1.04%|
|Present Value Discounted @ 10.79%||HK$7.23k||HK$6.85k||HK$6.25k||HK$5.70k||HK$5.20k|
Present Value of 5-year Cash Flow (PVCF)= HK$31b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. 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 10.8%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = HK$8.7b × (1 + 2.2%) ÷ (10.8% – 2.2%) = HK$103b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK$103b ÷ ( 1 + 10.8%)5 = HK$62b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is HK$93b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of HK$13.34. Relative to the current share price of HK$7.23, the stock is quite good value at a 46% discount to what it is available for right now.
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 China Resources Cement Holdings 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 10.8%, which is based on a levered beta of 1.101. 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.
Whilst important, DCF calculation 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 1313, I’ve put together three important aspects you should further research:
- Financial Health: Does 1313 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 1313’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 1313? 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.
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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 email@example.com.