Are investors undervaluing Huazhu Group Limited (NASDAQ:HTHT) by 42%?
How far is Huazhu Group Limited (NASDAQ:HTHT) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by estimating the company’s future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Huazhu Group
Is the Huazhu Group correctly valued?
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (CN¥, Million)||CN¥668.0m||CN¥2.89b||CN¥4.63b||CN¥6.05b||CN¥7.37b||CN¥8.54b||CN¥9.54b||CN¥10.4b||CN¥11.1b||CN¥11.7b|
|Growth rate estimate Source||Analyst x3||Analyst x3||Analyst x3||Is at 30.46%||Is at 21.89%||Is at 15.9%||Is at 11.71%||Is at 8.77%||Is at 6.72%||Is at 5.28%|
|Present value (CN¥, million) discounted at 8.6%||CN¥615||CN¥2.4k||CN¥3.6k||CN¥4.3k||CN¥4.9k||CN¥5.2k||CN¥5.4k||CN¥5.4k||CN¥5.3k||CN¥5.1k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥42b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. 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 1.9%. We discount terminal cash flows to present value at a cost of equity of 8.6%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥12b × (1 + 1.9%) ÷ (8.6%–1.9%) = CN¥178b
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥178b÷ ( 1 + 8.6%)ten= CN¥78b
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 120 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $32.5, the company looks quite undervalued at a 42% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
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 the Huazhu Group 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 8.6%, which is based on a leveraged beta of 1.354. 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.
Although a business valuation is important, it is only one of many factors you need to assess for a business. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. Why is the stock price below intrinsic value? For Huazhu Group, we have collected three additional aspects that you should consider in more detail:
- Risks: You should be aware of the 1 warning sign for Huazhu Group we found out before considering an investment in the business.
- Future earnings: How does HTHT’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQGS stock. If you want to find the calculation for other stocks, 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.