Are Investors Undervaluing Haitian International Holdings Limited (HKG:1882) By 24%?

Key Insights

• Haitian International Holdings' estimated fair value is CN¥30.6 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥23.3 suggests Haitian International Holdings is 24% undervalued
• Analyst price target for 1882 is CN¥23.75 which is 22% below our fair value estimate

How far off is Haitian International Holdings Limited (HKG:1882) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Haitian International Holdings

What's The Estimated Valuation?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥2.21b	CN¥2.54b	CN¥2.77b	CN¥2.97b	CN¥3.12b	CN¥3.26b	CN¥3.37b	CN¥3.47b	CN¥3.56b	CN¥3.64b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 9.30%	Est @ 6.99%	Est @ 5.38%	Est @ 4.25%	Est @ 3.46%	Est @ 2.91%	Est @ 2.52%	Est @ 2.25%
Present Value (CN¥, Millions) Discounted @ 8.7%	CN¥2.0k	CN¥2.1k	CN¥2.2k	CN¥2.1k	CN¥2.1k	CN¥2.0k	CN¥1.9k	CN¥1.8k	CN¥1.7k	CN¥1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥19b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 have used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.7%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥3.6b× (1 + 1.6%) ÷ (8.7%– 1.6%) = CN¥52b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥52b÷ ( 1 + 8.7%)¹⁰= CN¥23b

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¥42b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$23.3, the company appears a touch undervalued at a 24% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Haitian International 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 8.7%, which is based on a levered beta of 1.029. 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 Haitian International Holdings

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Haitian International Holdings, we've put together three relevant factors you should explore:

1. Risks: For instance, we've identified 1 warning sign for Haitian International Holdings that you should be aware of.
2. Future Earnings: How does 1882'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 Solid Businesses: 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 business 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.

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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.