Calculating The Intrinsic Value Of China Gingko Education Group Company Limited (HKG:1851)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China Gingko Education Group fair value estimate is HK$2.66
• China Gingko Education Group's HK$2.43 share price indicates it is trading at similar levels as its fair value estimate
• China Gingko Education Group's peers are currently trading at a premium of 40% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of China Gingko Education Group Company Limited (HKG:1851) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥67.0m	CN¥65.4m	CN¥64.9m	CN¥65.1m	CN¥65.8m	CN¥66.9m	CN¥68.2m	CN¥69.7m	CN¥71.4m	CN¥73.2m
Growth Rate Estimate Source	Est @ -4.46%	Est @ -2.28%	Est @ -0.75%	Est @ 0.32%	Est @ 1.07%	Est @ 1.60%	Est @ 1.96%	Est @ 2.22%	Est @ 2.40%	Est @ 2.53%
Present Value (CN¥, Millions) Discounted @ 7.6%	CN¥62.2	CN¥56.5	CN¥52.1	CN¥48.5	CN¥45.5	CN¥43.0	CN¥40.7	CN¥38.7	CN¥36.8	CN¥35.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥459m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.8%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥73m× (1 + 2.8%) ÷ (7.6%– 2.8%) = CN¥1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.6b÷ ( 1 + 7.6%)¹⁰= CN¥746m

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¥1.2b. 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$2.4, the company appears about fair value at a 8.7% discount to where the stock price trades currently. 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

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 China Gingko Education Group 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 7.6%, which is based on a levered beta of 0.920. 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.

See our latest analysis for China Gingko Education Group

SWOT Analysis for China Gingko Education Group

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For China Gingko Education Group, we've compiled three relevant factors you should further examine:

1. Financial Health: Does 1851 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
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.