Stock Analysis

Is There An Opportunity With Bosideng International Holdings Limited's (HKG:3998) 46% Undervaluation?

SEHK:3998
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Key Insights

In this article we are going to estimate the intrinsic value of Bosideng International Holdings Limited (HKG:3998) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. 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 Bosideng International 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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥4.11b CN¥4.05b CN¥4.88b CN¥4.52b CN¥4.32b CN¥4.22b CN¥4.18b CN¥4.18b CN¥4.21b CN¥4.26b
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Analyst x1 Est @ -4.28% Est @ -2.32% Est @ -0.95% Est @ 0.01% Est @ 0.68% Est @ 1.15%
Present Value (CN¥, Millions) Discounted @ 7.7% CN¥3.8k CN¥3.5k CN¥3.9k CN¥3.4k CN¥3.0k CN¥2.7k CN¥2.5k CN¥2.3k CN¥2.2k CN¥2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥29b

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥4.3b× (1 + 2.3%) ÷ (7.7%– 2.3%) = CN¥80b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥80b÷ ( 1 + 7.7%)10= CN¥38b

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 CN¥67b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$3.6, the company appears quite good value at a 46% 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.

dcf
SEHK:3998 Discounted Cash Flow September 14th 2024

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Bosideng 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 7.7%, which is based on a levered beta of 1.124. 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 Bosideng International Holdings

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Luxury market.
Opportunity
  • Annual earnings are forecast to grow faster than the Hong Kong market.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Revenue is forecast to grow slower than 20% per year.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Bosideng International Holdings, we've compiled three additional elements you should look at:

  1. Risks: Take risks, for example - Bosideng International Holdings has 2 warning signs we think you should be aware of.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 3998's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. 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.

Valuation is complex, but we're here to simplify it.

Discover if Bosideng International Holdings might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.