A Look At The Intrinsic Value Of Hidili Industry International Development Limited (HKG:1393)

Key Insights

• The projected fair value for Hidili Industry International Development is HK$0.28 based on 2 Stage Free Cash Flow to Equity
• With HK$0.33 share price, Hidili Industry International Development appears to be trading close to its estimated fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hidili Industry International Development Limited (HKG:1393) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Hidili Industry International Development

Is Hidili Industry International Development Fairly Valued?

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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥165.7m	CN¥166.6m	CN¥168.0m	CN¥170.0m	CN¥172.3m	CN¥174.8m	CN¥177.6m	CN¥180.5m	CN¥183.6m	CN¥186.7m
Growth Rate Estimate Source	Est @ -0.07%	Est @ 0.49%	Est @ 0.88%	Est @ 1.16%	Est @ 1.35%	Est @ 1.49%	Est @ 1.58%	Est @ 1.65%	Est @ 1.69%	Est @ 1.72%
Present Value (CN¥, Millions) Discounted @ 16%	CN¥143	CN¥124	CN¥107	CN¥93.5	CN¥81.6	CN¥71.3	CN¥62.4	CN¥54.6	CN¥47.8	CN¥41.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥827m

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥187m× (1 + 1.8%) ÷ (16%– 1.8%) = CN¥1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.3b÷ ( 1 + 16%)¹⁰= CN¥298m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥1.1b. In the final step we 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.

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 Hidili Industry International Development 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 16%, 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.

SWOT Analysis for Hidili Industry International Development

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. For Hidili Industry International Development, we've put together three fundamental items you should assess:

1. Risks: Be aware that Hidili Industry International Development is showing 3 warning signs in our investment analysis , and 2 of those can't be ignored...
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1393'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.