A Look At The Intrinsic Value Of Grand Ocean Advanced Resources Company Limited (HKG:65)

Key Insights

• Grand Ocean Advanced Resources' estimated fair value is HK$0.36 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.33 suggests Grand Ocean Advanced Resources is potentially trading close to its fair value
• When compared to theindustry average discount to fair value of 8.6%, Grand Ocean Advanced Resources' competitors seem to be trading at a greater discount

Does the April share price for Grand Ocean Advanced Resources Company Limited (HKG:65) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Grand Ocean Advanced Resources

The Model

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. 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$45.7m	HK$46.0m	HK$46.5m	HK$47.1m	HK$47.7m	HK$48.5m	HK$49.2m	HK$50.0m	HK$50.8m	HK$51.7m
Growth Rate Estimate Source	Est @ 0.27%	Est @ 0.71%	Est @ 1.02%	Est @ 1.23%	Est @ 1.39%	Est @ 1.49%	Est @ 1.57%	Est @ 1.62%	Est @ 1.66%	Est @ 1.68%
Present Value (HK$, Millions) Discounted @ 10.0%	HK$41.6	HK$38.1	HK$35.0	HK$32.2	HK$29.7	HK$27.4	HK$25.3	HK$23.4	HK$21.6	HK$20.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$294m

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. 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 (1.7%) 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 10.0%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$52m× (1 + 1.7%) ÷ (10.0%– 1.7%) = HK$640m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$640m÷ ( 1 + 10.0%)¹⁰= HK$248m

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$542m. 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$0.3, the company appears about fair value at a 8.5% discount to where the stock price trades currently. 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

Now 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 Grand Ocean Advanced Resources 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 10.0%, which is based on a levered beta of 1.179. 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 Grand Ocean Advanced Resources

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 Grand Ocean Advanced Resources, we've put together three relevant elements you should further research:

1. Risks: Every company has them, and we've spotted 4 warning signs for Grand Ocean Advanced Resources you should know about.
2. 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!
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. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock 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.