Does SSY Group Limited (HKG: 2005) trade at a 50% discount?
Does the January price of SSY Group Limited (HKG: 2005) stock reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Check out our latest analysis for the SSY group
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth, and the second stage is lower growth stage. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of those future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) forecast
|Leverage FCF (HK $, Million)||HK $ 1.01 billion||HK $ 997.5 million||HK $ 992.3 million||HK $ 993.1 million||HK $ 998.1 million||HK $ 1.01 billion||HK $ 1.02 billion||HK $ 1.03 billion||HK $ 1.04 billion||HK $ 1.05 billion|
|Source of estimated growth rate||Analyst x2||Analyst x2||East @ -0.52%||Is 0.08%||Is @ 0.5%||Is @ 0.79%||Is @ 1%||Is @ 1.14%||Est @ 1.24%||Est @ 1.32%|
|Present value (HK $, Million) discounted at 5.4%||HK $ 961||898 HK $||848 HK $||HK $ 805||768 HK $||734 HK $||HK $ 704||675 HK $||649 HK $||624 HK $|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = HK $ 7.7 billion
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 5.4%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK $ 1.1 billion × (1 + 1.5%) ÷ (5.4% – 1.5%) = HK $ 27 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= HK $ 27 billion ÷ (1 + 5.4%)ten= HK $ 16 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is HK $ 24 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of 4.0 Hong Kong dollars, the company appears to be quite undervalued with a 50% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 full picture of a company’s potential performance. Since we view the SSY 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 have used 5.4% which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid 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 undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Why is intrinsic value greater than the current share price? For the SSY group, we’ve compiled three more things you should explore:
- Risks: Consider for example the ever-present specter of investment risk. We have identified 2 warning signs with SSY Group, and understanding them should be part of your investment process.
- Future benefits: How does the 2005 growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.