A Look At The Fair Value Of Beijing Health (Holdings) Limited (HKG:2389)

Today we will run through one way of estimating the intrinsic value of Beijing Health (Holdings) Limited (HKG:2389) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Beijing Health (Holdings)

The Method

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. 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$32.0m	HK$38.6m	HK$44.4m	HK$49.3m	HK$53.3m	HK$56.6m	HK$59.4m	HK$61.7m	HK$63.8m	HK$65.6m
Growth Rate Estimate Source	Est @ 28.63%	Est @ 20.56%	Est @ 14.92%	Est @ 10.96%	Est @ 8.20%	Est @ 6.26%	Est @ 4.90%	Est @ 3.95%	Est @ 3.29%	Est @ 2.83%
Present Value (HK$, Millions) Discounted @ 7.3%	HK$29.9	HK$33.5	HK$35.9	HK$37.1	HK$37.4	HK$37.1	HK$36.2	HK$35.1	HK$33.8	HK$32.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$348m

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 (1.7%) 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 7.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$66m× (1 + 1.7%) ÷ (7.3%– 1.7%) = HK$1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$1.2b÷ ( 1 + 7.3%)¹⁰= HK$591m

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 HK$939m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.1, the company appears about fair value at a 6.4% 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.

Important 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 Beijing Health (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 7.3%, 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.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. For Beijing Health (Holdings), we've put together three relevant factors you should further research:

1. Risks: You should be aware of the 2 warning signs for Beijing Health (Holdings) we've uncovered before considering an investment in the company.
2. 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!
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.