Calculating The Fair Value Of Regal Hotels International Holdings Limited (HKG:78)

Key Insights

• Regal Hotels International Holdings' estimated fair value is HK$3.10 based on 2 Stage Free Cash Flow to Equity
• With HK$2.60 share price, Regal Hotels International Holdings appears to be trading close to its estimated fair value
• Regal Hotels International Holdings' peers seem to be trading at a higher discount to fair value based onthe industry average of 20%

Does the February share price for Regal Hotels International Holdings Limited (HKG:78) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Regal Hotels International Holdings

Step By Step Through 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. 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$361.3m	HK$342.9m	HK$332.8m	HK$328.0m	HK$326.7m	HK$327.8m	HK$330.5m	HK$334.5m	HK$339.4m	HK$344.9m
Growth Rate Estimate Source	Est @ -8.13%	Est @ -5.08%	Est @ -2.95%	Est @ -1.45%	Est @ -0.40%	Est @ 0.33%	Est @ 0.84%	Est @ 1.20%	Est @ 1.45%	Est @ 1.63%
Present Value (HK$, Millions) Discounted @ 13%	HK$320	HK$269	HK$231	HK$201	HK$177	HK$157	HK$141	HK$126	HK$113	HK$102

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$1.8b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$345m× (1 + 2.0%) ÷ (13%– 2.0%) = HK$3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$3.2b÷ ( 1 + 13%)¹⁰= HK$946m

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$2.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$2.6, the company appears about fair value at a 16% 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Regal Hotels International 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 13%, which is based on a levered beta of 2.000. 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 shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Regal Hotels International Holdings, we've compiled three relevant items you should further research:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Regal Hotels International Holdings .
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. 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.