Calculating The Fair Value Of Lisi Group (Holdings) Limited (HKG:526)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Lisi Group (Holdings) fair value estimate is HK$0.047
• Current share price of HK$0.049 suggests Lisi Group (Holdings) is potentially trading close to its fair value
• Lisi Group (Holdings)'s peers seem to be trading at a higher premium to fair value based onthe industry average of -45%

In this article we are going to estimate the intrinsic value of Lisi Group (Holdings) Limited (HKG:526) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing 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 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. 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 Lisi Group (Holdings)

Step By Step Through The Calculation

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥63.7m	CN¥55.6m	CN¥51.0m	CN¥48.3m	CN¥46.8m	CN¥46.0m	CN¥45.7m	CN¥45.7m	CN¥45.9m	CN¥46.4m
Growth Rate Estimate Source	Est @ -18.76%	Est @ -12.61%	Est @ -8.31%	Est @ -5.29%	Est @ -3.18%	Est @ -1.71%	Est @ -0.67%	Est @ 0.05%	Est @ 0.56%	Est @ 0.91%
Present Value (CN¥, Millions) Discounted @ 16%	CN¥55.0	CN¥41.6	CN¥33.0	CN¥27.0	CN¥22.6	CN¥19.2	CN¥16.5	CN¥14.2	CN¥12.4	CN¥10.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥252m

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. 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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥46m× (1 + 1.7%) ÷ (16%– 1.7%) = CN¥338m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥338m÷ ( 1 + 16%)¹⁰= CN¥79m

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¥331m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.05, 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.

Important Assumptions

We would point out that 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 Lisi 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 16%, which is based on a levered beta of 2.000. 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 Lisi Group (Holdings)

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For Lisi Group (Holdings), we've compiled three essential factors you should explore:

1. Risks: We feel that you should assess the 3 warning signs for Lisi Group (Holdings) (2 don't sit too well with us!) we've flagged before making an investment in the company.
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 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.