Are investors undervaluing Tongcheng Travel Holdings Limited (HKG:780) by 38%?
In this article, we will estimate the intrinsic value of Tongcheng Travel Holdings Limited (HKG:780) by taking expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model for this purpose. 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. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Tongcheng Travel Holdings
What is the estimated valuation?
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. To start, we need to estimate the cash flows for 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.
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¥1.52b | CN¥1.89b | CN¥1.75b | CN¥2.13b | CN¥2.27b | CN¥2.39b | CN¥2.49b | CN¥2.57b | CN¥2.65b | CN¥2.71b |
Growth rate estimate Source | Analyst x5 | Analyst x6 | Analyst x2 | Analyst x1 | Is at 6.9% | Is at 5.27% | Is at 4.13% | Is at 3.34% | Is at 2.78% | Is at 2.39% |
Present value (CN¥, million) discounted at 6.9% | CN¥1.4k | CN¥1.7k | CN¥1.4k | CN¥1.6k | CN¥1.6k | CN¥1.6k | CN¥1.6k | CN¥1.5k | CN¥1.5k | CN¥1.4k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥15b
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 the terminal cash flows to present value at a cost of equity of 6.9%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = CN¥2.7b × (1 + 1.5%) ÷ (6.9%–1.5%) = CN¥51b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= CN¥51b÷ ( 1 + 6.9%)^{ten}= CN¥26b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 42 billion yen. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of HK$14.2, the company looks quite undervalued at a 38% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
Important assumptions
Now, 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 these entries, I recommend you redo the calculations yourself and play around with them. 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 Tongcheng Travel 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 6.9%, which is based on a leveraged beta of 1.092. 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:
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Can we understand why the company is trading at a discount to its intrinsic value? For Tongcheng Travel Holdings, we have compiled three important factors you should explore:
- Risks: For this purpose, you must know the 1 warning sign we spotted with Tongcheng Travel Holdings.
- Future earnings: How does the growth rate of the 780 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 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!
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.