An Intrinsic Calculation For Hengdian Entertainment Co.,LTD (SHSE:603103) Suggests It's 25% Undervalued

Key Insights

• Hengdian EntertainmentLTD's estimated fair value is CN¥14.61 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥10.94 suggests Hengdian EntertainmentLTD is potentially 25% undervalued
• Hengdian EntertainmentLTD's peers are currently trading at a premium of 604% on average

Does the August share price for Hengdian Entertainment Co.,LTD (SHSE:603103) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Hengdian EntertainmentLTD

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥506.8m	CN¥544.1m	CN¥576.7m	CN¥605.9m	CN¥632.5m	CN¥657.4m	CN¥681.1m	CN¥704.1m	CN¥726.8m	CN¥749.4m
Growth Rate Estimate Source	Est @ 9.28%	Est @ 7.35%	Est @ 6.00%	Est @ 5.06%	Est @ 4.39%	Est @ 3.93%	Est @ 3.61%	Est @ 3.38%	Est @ 3.22%	Est @ 3.11%
Present Value (CN¥, Millions) Discounted @ 9.0%	CN¥465	CN¥458	CN¥445	CN¥429	CN¥411	CN¥392	CN¥373	CN¥353	CN¥335	CN¥316

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥4.0b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥749m× (1 + 2.9%) ÷ (9.0%– 2.9%) = CN¥13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥13b÷ ( 1 + 9.0%)¹⁰= CN¥5.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥9.3b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥10.9, the company appears a touch undervalued at a 25% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Hengdian EntertainmentLTD 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 accounts for debt. In this calculation we've used 9.0%, which is based on a levered beta of 1.235. Beta is a measure of a stock's volatility, compared 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.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Hengdian EntertainmentLTD, we've put together three fundamental aspects you should further research:

1. Risks: For example, we've discovered 1 warning sign for Hengdian EntertainmentLTD that you should be aware of before investing here.
2. Future Earnings: How does 603103's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.