Estimating The Intrinsic Value Of Chuanglian Holdings Limited (HKG:2371)

Key Insights

• Chuanglian Holdings' estimated fair value is HK$0.026 based on 2 Stage Free Cash Flow to Equity
• Chuanglian Holdings' HK$0.03 share price indicates it is trading at similar levels as its fair value estimate
• Chuanglian Holdings' peers seem to be trading at a higher premium to fair value based onthe industry average of -43%

In this article we are going to estimate the intrinsic value of Chuanglian Holdings Limited (HKG:2371) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for Chuanglian Holdings

What's The Estimated Valuation?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥12.8m	CN¥11.7m	CN¥11.1m	CN¥10.8m	CN¥10.6m	CN¥10.5m	CN¥10.5m	CN¥10.6m	CN¥10.7m	CN¥10.9m
Growth Rate Estimate Source	Est @ -12.71%	Est @ -8.33%	Est @ -5.27%	Est @ -3.12%	Est @ -1.62%	Est @ -0.57%	Est @ 0.16%	Est @ 0.68%	Est @ 1.04%	Est @ 1.29%
Present Value (CN¥, Millions) Discounted @ 7.8%	CN¥11.9	CN¥10.1	CN¥8.9	CN¥8.0	CN¥7.3	CN¥6.7	CN¥6.2	CN¥5.8	CN¥5.4	CN¥5.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥75m

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 (1.9%) 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 7.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥11m× (1 + 1.9%) ÷ (7.8%– 1.9%) = CN¥186m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥186m÷ ( 1 + 7.8%)¹⁰= CN¥87m

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¥162m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.03, 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.

The 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 Chuanglian 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 7.8%, which is based on a levered beta of 1.010. 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:

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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Chuanglian Holdings, there are three essential items you should assess:

1. Risks: Every company has them, and we've spotted 4 warning signs for Chuanglian Holdings you should know about.
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 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.