The intrinsic value of Excellence Commercial Property & Facilities Management Group Limited (HKG: 6989) is potentially 24% lower than its share price
Today we’re going to walk through one way to estimate the intrinsic value of Excellence Commercial Property & Facilities Management Group Limited (HKG: 6989) by taking expected future cash flows and discounting them to present value. The DCF (Discounted Cash Flow) model is the tool we will apply to do this. There really isn’t much to do, although it might seem quite complex.
We would like to point out that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are learning equity analysis in depth, the Simply Wall St analysis template here may be of interest to you.
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We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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 the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:
10-year Free Cash Flow (FCF) forecast
|Leverage FCF (CN ¥, million)||CNY 458.0 million||CNY 459.0 million||CNY 461.7 million||CNY 465.6 million||CNY 470.5 million||CNY 476 million||CNY 482.0 million||CNY 488.4 million||CNY 495.1 million||CNY 502.1 million|
|Source of estimated growth rate||Analyst x1||Analyst x1||Is 0.58%||Is 0.85%||Is 1.04%||Is 1.17%||Is 1.27%||Is 1.33%||Is 1.37%||Is at 1.41%|
|Present value (CN ¥, million) discounted at 7.3%||427 CNY||399 CNY||374 CNY||352 CNY||331 CNY||313 CNY||295 CNY||279 CNY||263 CNY||249 CNY|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 3.3 billion yen
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. For a number of reasons, a very conservative growth rate is used that 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 7.3%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN ¥ 502m × (1 + 1.5%) ÷ (7.3% – 1.5%) = CN ¥ 8.8b
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN ¥ 8.8b ÷ (1 + 7.3%)ten= 4.4 billion yen
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is 7.7 billion yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 9.9, the company looks potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play 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 view Excellence Commercial Property & Facilities Management 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 into account the debt. In this calculation, we used 7.3%, which is based on a leveraged beta of 1.071. 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 globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, ideally it won’t be the only analysis you review for a business. The DCF model is not a perfect inventory valuation tool. 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. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price exceeds intrinsic value? For Excellence Commercial Property & Facilities Management Group, we have put together three relevant things that you should explore:
- Financial health: 6989 Does he have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future income: How does the growth rate of 6989 compare to its competition and to the overall market? Dig deeper into the analyst consensus count for years to come 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 inventory to get a feel for what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you’re looking 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. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
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