A Look At The Fair Value Of Hing Ming Holdings Limited (HKG:8425)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Hing Ming Holdings fair value estimate is HK$0.19
• Current share price of HK$0.20 suggests Hing Ming Holdings is potentially trading close to its fair value
• When compared to theindustry average discount of -194%, Hing Ming Holdings' competitors seem to be trading at a greater premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hing Ming Holdings Limited (HKG:8425) as an investment opportunity by estimating the company's future cash flows and discounting them to their present 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.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Hing Ming Holdings

The Method

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. To start off with, we need to estimate the next ten years of cash flows. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$4.37m	HK$4.70m	HK$4.98m	HK$5.21m	HK$5.41m	HK$5.59m	HK$5.75m	HK$5.89m	HK$6.03m	HK$6.16m
Growth Rate Estimate Source	Est @ 10.02%	Est @ 7.58%	Est @ 5.87%	Est @ 4.67%	Est @ 3.84%	Est @ 3.25%	Est @ 2.84%	Est @ 2.55%	Est @ 2.35%	Est @ 2.21%
Present Value (HK$, Millions) Discounted @ 8.8%	HK$4.0	HK$4.0	HK$3.9	HK$3.7	HK$3.5	HK$3.4	HK$3.2	HK$3.0	HK$2.8	HK$2.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$34m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (1.9%) 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 8.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$6.2m× (1 + 1.9%) ÷ (8.8%– 1.9%) = HK$90m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$90m÷ ( 1 + 8.8%)¹⁰= HK$39m

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$73m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$0.2, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The 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 Hing Ming 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 8.8%, which is based on a levered beta of 1.148. 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.

Looking Ahead:

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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Hing Ming Holdings, we've compiled three relevant elements you should further examine:

1. Risks: Be aware that Hing Ming Holdings is showing 3 warning signs in our investment analysis , and 2 of those are potentially serious...
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.