A Look At The Fair Value Of Hysan Development Company Limited (HKG:14)

Key Insights

• Hysan Development's estimated fair value is HK$20.59 based on 2 Stage Free Cash Flow to Equity
• With HK$22.35 share price, Hysan Development appears to be trading close to its estimated fair value
• Our fair value estimate is 30% lower than Hysan Development's analyst price target of HK$29.46

Does the March share price for Hysan Development Company Limited (HKG:14) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 Hysan Development

Is Hysan Development Fairly Valued?

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. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$2.39b	HK$2.18b	HK$2.62b	HK$2.72b	HK$2.81b	HK$2.88b	HK$2.96b	HK$3.02b	HK$3.09b	HK$3.15b
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x1	Est @ 3.84%	Est @ 3.21%	Est @ 2.77%	Est @ 2.46%	Est @ 2.24%	Est @ 2.09%	Est @ 1.99%
Present Value (HK$, Millions) Discounted @ 14%	HK$2.1k	HK$1.7k	HK$1.8k	HK$1.6k	HK$1.5k	HK$1.3k	HK$1.2k	HK$1.1k	HK$954	HK$854

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$14b

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 14%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$3.1b× (1 + 1.7%) ÷ (14%– 1.7%) = HK$26b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$26b÷ ( 1 + 14%)¹⁰= HK$7.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK$21b. 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$22.4, the company appears around fair value at the time of writing. 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Hysan Development 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 14%, which is based on a levered beta of 1.748. 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 Hysan Development

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Hysan Development, we've compiled three important factors you should assess:

1. Risks: Every company has them, and we've spotted 1 warning sign for Hysan Development you should know about.
2. Future Earnings: How does 14'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.