Calculating The Intrinsic Value Of K. H. Group Holdings Limited (HKG:1557)

Key Insights

• K. H. Group Holdings' estimated fair value is HK$0.71 based on 2 Stage Free Cash Flow to Equity
• K. H. Group Holdings' HK$0.61 share price indicates it is trading at similar levels as its fair value estimate
• Peers of K. H. Group Holdings are currently trading on average at a 61% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of K. H. Group Holdings Limited (HKG:1557) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for K. H. Group Holdings

Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

Generally we assume that a dollar today is more valuable 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$24.7m	HK$23.5m	HK$22.9m	HK$22.6m	HK$22.5m	HK$22.6m	HK$22.7m	HK$23.0m	HK$23.3m	HK$23.7m
Growth Rate Estimate Source	Est @ -7.79%	Est @ -4.86%	Est @ -2.81%	Est @ -1.38%	Est @ -0.37%	Est @ 0.33%	Est @ 0.82%	Est @ 1.17%	Est @ 1.41%	Est @ 1.58%
Present Value (HK$, Millions) Discounted @ 9.2%	HK$22.7	HK$19.7	HK$17.6	HK$15.9	HK$14.5	HK$13.3	HK$12.3	HK$11.4	HK$10.5	HK$9.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$148m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$24m× (1 + 2.0%) ÷ (9.2%– 2.0%) = HK$333m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$333m÷ ( 1 + 9.2%)¹⁰= HK$138m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is HK$285m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.6, the company appears about fair value at a 15% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now 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 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 K. H. Group 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 accounts for debt. In this calculation we've used 9.2%, which is based on a levered beta of 1.227. 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.

SWOT Analysis for K. H. Group Holdings

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For K. H. Group Holdings, we've compiled three fundamental aspects you should further examine:

1. Risks: We feel that you should assess the 4 warning signs for K. H. Group Holdings (2 shouldn't be ignored!) we've flagged before making an investment in the company.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.

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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.