Is China Resources Beer (Holdings) Company Limited (HKG:291) Trading At A 25% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China Resources Beer (Holdings) fair value estimate is HK$47.62
• China Resources Beer (Holdings) is estimated to be 25% undervalued based on current share price of HK$35.60
• The CN¥49.83 analyst price target for 291 is 4.6% more than our estimate of fair value

How far off is China Resources Beer (Holdings) Company Limited (HKG:291) 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 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 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.

See our latest analysis for China Resources Beer (Holdings)

The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥5.85b	CN¥7.16b	CN¥8.04b	CN¥5.26b	CN¥7.38b	CN¥7.27b	CN¥7.24b	CN¥7.26b	CN¥7.32b	CN¥7.41b
Growth Rate Estimate Source	Analyst x11	Analyst x12	Analyst x11	Analyst x1	Analyst x1	Est @ -1.51%	Est @ -0.45%	Est @ 0.30%	Est @ 0.82%	Est @ 1.19%
Present Value (CN¥, Millions) Discounted @ 6.4%	CN¥5.5k	CN¥6.3k	CN¥6.7k	CN¥4.1k	CN¥5.4k	CN¥5.0k	CN¥4.7k	CN¥4.4k	CN¥4.2k	CN¥4.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥50b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.0%) 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 6.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥7.4b× (1 + 2.0%) ÷ (6.4%– 2.0%) = CN¥172b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥172b÷ ( 1 + 6.4%)¹⁰= CN¥92b

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¥143b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$35.6, the company appears a touch undervalued at a 25% 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.

Important 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 China Resources Beer (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 6.4%, which is based on a levered beta of 0.800. 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 China Resources Beer (Holdings)

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. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For China Resources Beer (Holdings), we've compiled three relevant aspects you should further examine:

1. Financial Health: Does 291 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 291'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 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.