Estimating The Fair Value Of Cathay Media and Education Group Inc. (HKG:1981)

Key Insights

• Cathay Media and Education Group's estimated fair value is HK$1.67 based on 2 Stage Free Cash Flow to Equity
• Cathay Media and Education Group's HK$1.36 share price indicates it is trading at similar levels as its fair value estimate
• Cathay Media and Education Group's peers are currently trading at a premium of 293% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Cathay Media and Education Group Inc. (HKG:1981) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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 Cathay Media and Education Group

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

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¥624.0m	CN¥156.0m	CN¥194.0m	CN¥176.4m	CN¥166.1m	CN¥160.2m	CN¥157.1m	CN¥155.8m	CN¥155.8m	CN¥156.6m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -9.10%	Est @ -5.83%	Est @ -3.54%	Est @ -1.94%	Est @ -0.82%	Est @ -0.03%	Est @ 0.52%
Present Value (CN¥, Millions) Discounted @ 8.9%	CN¥573	CN¥132	CN¥150	CN¥125	CN¥108	CN¥96.0	CN¥86.4	CN¥78.7	CN¥72.3	CN¥66.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.5b

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 (1.8%) 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 8.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥157m× (1 + 1.8%) ÷ (8.9%– 1.8%) = CN¥2.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.2b÷ ( 1 + 8.9%)¹⁰= CN¥955m

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¥2.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$1.4, the company appears about fair value at a 19% 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

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. 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 Cathay Media and Education 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 8.9%, which is based on a levered beta of 0.993. 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 Cathay Media and Education Group

Next Steps:

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 Cathay Media and Education Group, there are three further items you should look at:

1. Risks: Take risks, for example - Cathay Media and Education Group has 1 warning sign we think you should be aware of.
2. Future Earnings: How does 1981'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 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!

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.