A look at the fair value of Bao Shen Holdings Limited (HKG:8151)
In this article, we will estimate the intrinsic value of Bao Shen Holdings Limited (HKG:8151) by estimating the company’s future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Bao Shen Holdings
The calculation
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-Year Free Cash Flow (FCF) Forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (CN¥, Million) | CN¥3.30m | CN¥3.54m | CN¥3.73m | CN¥3.89m | CN¥4.02m | CN¥4.13m | CN¥4.23m | CN¥4.32m | CN¥4.41m | CN¥4.49m |
Growth rate estimate Source | Is at 9.54% | Is at 7.12% | Is at 5.43% | Is at 4.25% | Is at 3.42% | Is at 2.83% | Is at 2.43% | Is at 2.14% | Is at 1.94% | Is at 1.81% |
Present value (CN¥, million) discounted at 8.5% | CN¥3.0 | CN¥3.0 | CN¥2.9 | CN¥2.8 | CN¥2.7 | CN¥2.5 | CN¥2.4 | CN¥2.3 | CN¥2.1 | CN¥2.0 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥25m
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.5%. We discount terminal cash flows to present value at a cost of equity of 8.5%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = CN¥4.5m × (1 + 1.5%) ÷ (8.5%– 1.5%) = CN¥65m
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= CN¥65m÷ ( 1 + 8.5%)^{ten}= CN¥29m
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 54 million yen. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK$0.1, the company appears to be about fair value at a 0.3% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Bao Shen 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 takes debt into account. In this calculation, we used 8.5%, which is based on a leveraged beta of 1.416. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
Although important, the DCF calculation is just one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Bao Shen Holdings, there are three relevant elements that you should examine in more detail:
- Risks: To this end, you should inquire about the 3 warning signs we spotted some with Bao Shen Holdings (including 2 that are a bit nasty).
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
- Other environmentally friendly businesses: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.