Calculating The Fair Value Of China Shun Ke Long Holdings Limited (HKG:974)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China Shun Ke Long Holdings fair value estimate is HK$0.49
• Current share price of HK$0.50 suggests China Shun Ke Long Holdings is potentially trading close to its fair value
• When compared to theindustry average discount of -18%, China Shun Ke Long 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 China Shun Ke Long Holdings Limited (HKG:974) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 China Shun Ke Long Holdings

The Model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥11.8m	CN¥9.84m	CN¥8.77m	CN¥8.16m	CN¥7.80m	CN¥7.61m	CN¥7.53m	CN¥7.51m	CN¥7.55m	CN¥7.62m
Growth Rate Estimate Source	Est @ -24.27%	Est @ -16.40%	Est @ -10.89%	Est @ -7.03%	Est @ -4.33%	Est @ -2.44%	Est @ -1.12%	Est @ -0.19%	Est @ 0.46%	Est @ 0.91%
Present Value (CN¥, Millions) Discounted @ 7.4%	CN¥11.0	CN¥8.5	CN¥7.1	CN¥6.1	CN¥5.5	CN¥5.0	CN¥4.6	CN¥4.3	CN¥4.0	CN¥3.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥60m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥7.6m× (1 + 2.0%) ÷ (7.4%– 2.0%) = CN¥144m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥144m÷ ( 1 + 7.4%)¹⁰= CN¥71m

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¥131m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 China Shun Ke Long 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 7.4%, which is based on a levered beta of 0.888. 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 China Shun Ke Long Holdings

Next Steps:

Whilst important, the DCF calculation 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. For China Shun Ke Long Holdings, we've put together three relevant items you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with China Shun Ke Long Holdings (at least 1 which is significant) , and understanding these should be part of your investment process.
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 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. 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.