Stock Analysis

Calculating The Fair Value Of Haidilao International Holding Ltd. (HKG:6862)

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SEHK:6862
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Does the December share price for Haidilao International Holding Ltd. (HKG:6862) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out the opportunities and risks within the HK Hospitality industry.

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 begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (CN¥, Millions) CN¥5.28b CN¥6.21b CN¥6.47b CN¥6.83b CN¥7.10b CN¥7.33b CN¥7.53b CN¥7.72b CN¥7.88b CN¥8.04b
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x1 Analyst x1 Est @ 3.98% Est @ 3.27% Est @ 2.77% Est @ 2.43% Est @ 2.19% Est @ 2.02%
Present Value (CN¥, Millions) Discounted @ 7.9% CN¥4.9k CN¥5.3k CN¥5.1k CN¥5.0k CN¥4.8k CN¥4.6k CN¥4.4k CN¥4.2k CN¥4.0k CN¥3.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥46b

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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥8.0b× (1 + 1.6%) ÷ (7.9%– 1.6%) = CN¥129b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥129b÷ ( 1 + 7.9%)10= CN¥60b

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¥106b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$19.1, the company appears about fair value at a 8.2% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
SEHK:6862 Discounted Cash Flow December 1st 2022

The 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 Haidilao International Holding 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 7.9%, which is based on a levered beta of 1.058. 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.

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. DCF models are not the be-all and end-all of investment valuation. 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 Haidilao International Holding, there are three fundamental items you should explore:

  1. Risks: For instance, we've identified 1 warning sign for Haidilao International Holding that you should be aware of.
  2. Future Earnings: How does 6862's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  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.

Valuation is complex, but we're helping make it simple.

Find out whether Haidilao International Holding is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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