Powerlong Real Estate Holdings Limited's (HKG:1238) Intrinsic Value Is Potentially 75% Above Its Share Price

Key Insights

• The projected fair value for Powerlong Real Estate Holdings is HK$1.72 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.98 suggests Powerlong Real Estate Holdings is potentially 43% undervalued
• Our fair value estimate is 8.0% lower than Powerlong Real Estate Holdings' analyst price target of CN¥1.87

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Powerlong Real Estate Holdings Limited (HKG:1238) as an investment opportunity 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 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Powerlong Real Estate Holdings

Is Powerlong Real Estate Holdings Fairly Valued?

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 start off with, we need to estimate the next ten years of cash flows. 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥5.26b	CN¥522.0m	CN¥724.0m	CN¥444.4m	CN¥326.6m	CN¥267.8m	CN¥235.5m	CN¥216.9m	CN¥206.0m	CN¥199.9m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -38.62%	Est @ -26.50%	Est @ -18.01%	Est @ -12.07%	Est @ -7.91%	Est @ -4.99%	Est @ -2.96%
Present Value (CN¥, Millions) Discounted @ 16%	CN¥4.5k	CN¥387	CN¥462	CN¥244	CN¥155	CN¥109	CN¥82.7	CN¥65.6	CN¥53.7	CN¥44.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥6.1b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥200m× (1 + 1.8%) ÷ (16%– 1.8%) = CN¥1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.4b÷ ( 1 + 16%)¹⁰= CN¥319m

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¥6.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$1.0, the company appears quite good value at a 43% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Powerlong Real Estate 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 16%, which is based on a levered beta of 2.000. 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 Powerlong Real Estate Holdings

Moving On:

Although the valuation of a company is important, it 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. 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. What is the reason for the share price sitting below the intrinsic value? For Powerlong Real Estate Holdings, there are three fundamental elements you should further examine:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Powerlong Real Estate Holdings (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
2. Future Earnings: How does 1238'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.