Are Investors Undervaluing Tongcheng Travel Holdings Limited (HKG:780) By 46%?

Key Insights

• The projected fair value for Tongcheng Travel Holdings is HK$31.75 based on 2 Stage Free Cash Flow to Equity
• Tongcheng Travel Holdings' HK$17.12 share price signals that it might be 46% undervalued
• Analyst price target for 780 is CN¥21.58 which is 32% below our fair value estimate

How far off is Tongcheng Travel Holdings Limited (HKG:780) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 our latest analysis for Tongcheng Travel Holdings

Is Tongcheng Travel Holdings Fairly Valued?

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥2.20b	CN¥2.60b	CN¥2.91b	CN¥3.77b	CN¥4.26b	CN¥4.67b	CN¥5.01b	CN¥5.29b	CN¥5.53b	CN¥5.73b
Growth Rate Estimate Source	Analyst x8	Analyst x7	Analyst x3	Analyst x2	Est @ 12.85%	Est @ 9.56%	Est @ 7.26%	Est @ 5.64%	Est @ 4.51%	Est @ 3.72%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥2.0k	CN¥2.2k	CN¥2.3k	CN¥2.7k	CN¥2.9k	CN¥2.9k	CN¥2.9k	CN¥2.8k	CN¥2.7k	CN¥2.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥26b

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 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥5.7b× (1 + 1.9%) ÷ (8.3%– 1.9%) = CN¥90b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥90b÷ ( 1 + 8.3%)¹⁰= CN¥41b

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¥66b. 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$17.1, the company appears quite good value at a 46% 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.

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. 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 Travel 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 8.3%, which is based on a levered beta of 1.065. 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.

SWOT Analysis for Tongcheng Travel Holdings

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Tongcheng Travel Holdings, we've compiled three essential items you should assess:

1. Risks: Take risks, for example - Tongcheng Travel Holdings has 2 warning signs we think you should be aware of.
2. Future Earnings: How does 780'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 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!

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.