A Look At The Fair Value Of South China Vocational Education Group Company Limited (HKG:6913)

Key Insights

• South China Vocational Education Group's estimated fair value is HK$0.29 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.29 suggests South China Vocational Education Group is potentially trading close to its fair value
• South China Vocational Education Group's peers seem to be trading at a higher premium to fair value based onthe industry average of -84%

In this article we are going to estimate the intrinsic value of South China Vocational Education Group Company Limited (HKG:6913) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

The Method

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 begin with, we have to get estimates of 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥21.7m	CN¥23.0m	CN¥24.2m	CN¥25.2m	CN¥26.2m	CN¥27.0m	CN¥27.9m	CN¥28.7m	CN¥29.4m	CN¥30.2m
Growth Rate Estimate Source	Est @ 7.71%	Est @ 6.13%	Est @ 5.02%	Est @ 4.25%	Est @ 3.70%	Est @ 3.33%	Est @ 3.06%	Est @ 2.87%	Est @ 2.74%	Est @ 2.65%
Present Value (CN¥, Millions) Discounted @ 9.0%	CN¥19.9	CN¥19.4	CN¥18.7	CN¥17.9	CN¥17.0	CN¥16.1	CN¥15.3	CN¥14.4	CN¥13.6	CN¥12.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥165m

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥30m× (1 + 2.4%) ÷ (9.0%– 2.4%) = CN¥475m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥475m÷ ( 1 + 9.0%)¹⁰= CN¥201m

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¥366m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.3, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important 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. 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 South China Vocational 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 9.0%, which is based on a levered beta of 1.238. 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.

View our latest analysis for South China Vocational Education Group

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 South China Vocational Education Group, there are three additional factors you should further research:

1. Risks: For instance, we've identified 4 warning signs for South China Vocational Education Group (1 is concerning) you should be aware of.
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.