Stock Analysis

Tongcheng-Elong Holdings Limited's (HKG:780) Intrinsic Value Is Potentially 76% Above Its Share Price

SEHK:780
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Does the August share price for Tongcheng-Elong Holdings Limited (HKG:780) 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. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Tongcheng-Elong Holdings

Is Tongcheng-Elong Holdings fairly valued?

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. 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CN¥, Millions) CN¥2.13b CN¥1.98b CN¥2.45b CN¥2.79b CN¥3.08b CN¥3.31b CN¥3.50b CN¥3.66b CN¥3.79b CN¥3.91b
Growth Rate Estimate Source Analyst x4 Analyst x5 Analyst x1 Est @ 14.02% Est @ 10.26% Est @ 7.63% Est @ 5.78% Est @ 4.49% Est @ 3.59% Est @ 2.96%
Present Value (CN¥, Millions) Discounted @ 7.6% CN¥2.0k CN¥1.7k CN¥2.0k CN¥2.1k CN¥2.1k CN¥2.1k CN¥2.1k CN¥2.0k CN¥2.0k CN¥1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥20b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥3.9b× (1 + 1.5%) ÷ (7.6%– 1.5%) = CN¥65b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥65b÷ ( 1 + 7.6%)10= CN¥31b

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¥52b. 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$15.9, the company appears quite good value at a 43% 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.

dcf
SEHK:780 Discounted Cash Flow August 16th 2021

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 Tongcheng-Elong 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 7.6%, which is based on a levered beta of 1.125. 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:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Tongcheng-Elong Holdings, we've compiled three pertinent items you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Tongcheng-Elong Holdings , and understanding these should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 780's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. 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.
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