- Hong Kong
- Medical Equipment
Calculating The Intrinsic Value Of Modern Dental Group Limited (HKG:3600)
- Using the 2 Stage Free Cash Flow to Equity, Modern Dental Group fair value estimate is HK$2.82
- Current share price of HK$2.76 suggests Modern Dental Group is potentially trading close to its fair value
- The average premium for Modern Dental Group's competitorsis currently 211%
In this article we are going to estimate the intrinsic value of Modern Dental Group Limited (HKG:3600) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Modern Dental Group
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
|Levered FCF (HK$, Millions)||HK$195.5m||HK$195.1m||HK$195.8m||HK$197.4m||HK$199.5m||HK$202.0m||HK$204.8m||HK$207.9m||HK$211.2m||HK$214.6m|
|Growth Rate Estimate Source||Est @ -1.06%||Est @ -0.22%||Est @ 0.37%||Est @ 0.78%||Est @ 1.07%||Est @ 1.27%||Est @ 1.41%||Est @ 1.51%||Est @ 1.58%||Est @ 1.63%|
|Present Value (HK$, Millions) Discounted @ 8.6%||HK$180||HK$165||HK$153||HK$142||HK$132||HK$123||HK$115||HK$107||HK$100||HK$93.7|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$1.3b
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 8.6%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = HK$215m× (1 + 1.7%) ÷ (8.6%– 1.7%) = HK$3.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$3.2b÷ ( 1 + 8.6%)10= HK$1.4b
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$2.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$2.8, the company appears about fair value at a 2.1% 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.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Modern Dental Group 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 8.6%, which is based on a levered beta of 0.990. 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 Modern Dental Group
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.
- Annual earnings are forecast to grow faster than the Hong Kong market.
- Good value based on P/E ratio and estimated fair value.
- No apparent threats visible for 3600.
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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For Modern Dental Group, we've compiled three further aspects you should explore:
- Risks: Be aware that Modern Dental Group is showing 3 warning signs in our investment analysis , you should know about...
- Future Earnings: How does 3600'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.
- 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.
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Find out whether Modern Dental Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Modern Dental Group
Modern Dental Group Limited, an investment holding company, engages in production and distribution of dental prosthetic devices in Europe, Greater China, North America, Australia, and internationally.
Flawless balance sheet and fair value.