Estimating The Intrinsic Value Of Perfect Medical Health Management Limited (HKG:1830)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Perfect Medical Health Management Limited (HKG:1830) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 Perfect Medical Health Management

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (HK$, Millions)	HK$542.4m	HK$545.2m	HK$549.6m	HK$555.1m	HK$561.5m	HK$568.5m	HK$576.0m	HK$583.9m	HK$592.1m	HK$600.5m
Growth Rate Estimate Source	Est @ 0.11%	Est @ 0.52%	Est @ 0.81%	Est @ 1.01%	Est @ 1.15%	Est @ 1.25%	Est @ 1.32%	Est @ 1.37%	Est @ 1.4%	Est @ 1.42%
Present Value (HK$, Millions) Discounted @ 6.0%	HK$512	HK$485	HK$462	HK$440	HK$420	HK$401	HK$384	HK$367	HK$351	HK$336

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$4.2b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.0%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = HK$601m× (1 + 1.5%) ÷ (6.0%– 1.5%) = HK$14b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$14b÷ ( 1 + 6.0%)¹⁰= HK$7.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK$12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$9.7, 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Perfect Medical Health Management 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 6.0%, which is based on a levered beta of 0.847. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Perfect Medical Health Management, we've compiled three additional elements you should assess:

1. Risks: Every company has them, and we've spotted 4 warning signs for Perfect Medical Health Management you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1830'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. 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. 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.
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