Calculation of the fair value of Leading Holdings Group Limited (HKG:6999)
How far is Leading Holdings Group Limited (HKG:6999) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair 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. This may sound complicated, but it’s actually quite simple!
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. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
See our latest analysis for Leading Holdings Group
crush numbers
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 begin with, we need to obtain cash flow estimates for 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, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (CN¥, Million) | 327.8 million Canadian yen | 348.4 million Canadian yen | CN¥365.3m | 379.4 million Canadian yen | 391.3 million Canadian yen | CN¥401.6m | 410.8 million Canadian yen | 419.2 million Canadian yen | 427.1 million Canadian yen | CN¥434.6m |
Growth rate estimate Source | Is at 8.37% | Is at 6.3% | Is at 4.86% | Is at 3.84% | Is at 3.13% | Is at 2.64% | Is at 2.29% | Is at 2.05% | Is at 1.88% | Is at 1.76% |
Present value (CN¥, million) discounted at 11% | CN¥294 | CN¥281 | CN¥265 | CN¥247 | CN¥228 | CN¥211 | CN¥193 | CN¥177 | CN¥162 | CN¥148 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥2.2b
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.5%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 11%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = CN¥435m × (1 + 1.5%) ÷ (11%– 1.5%) = CN¥4.5b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= CN¥4.5b÷ ( 1 + 11%)^{ten}= CN¥1.5b
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 3.7 trillion Canadian 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$4.1, the company appears to be about fair value at a 9.1% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
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 Leading Holdings 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 11%, which is based on a leveraged beta of 2,000. 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.
Let’s move on :
While valuing a business is important, it ideally won’t 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. 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. For Leading Holdings Group, we’ve put together three more things you should consider:
- Risks: For example, we spotted 3 warning signs for Leading Holdings Group you should be aware of, and 1 of them is potentially serious.
- Management: Did insiders increase their shares to take advantage of market sentiment regarding the future prospects of 6999? View our management and board analysis with insights into CEO compensation and governance factors.
- 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. The Simply Wall St app performs an updated cash flow valuation for each SEHK stock every day. 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.