A Look At The Fair Value Of Ronshine Service Holding Co., Ltd (HKG:2207)

Key Insights

• Ronshine Service Holding's estimated fair value is HK$0.52 based on 2 Stage Free Cash Flow to Equity
• With HK$0.56 share price, Ronshine Service Holding appears to be trading close to its estimated fair value

How far off is Ronshine Service Holding Co., Ltd (HKG:2207) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and 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!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Ronshine Service Holding

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. To begin with, we have to get estimates of 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥34.7m	CN¥24.7m	CN¥19.9m	CN¥17.3m	CN¥15.9m	CN¥15.0m	CN¥14.5m	CN¥14.3m	CN¥14.2m	CN¥14.3m
Growth Rate Estimate Source	Est @ -41.82%	Est @ -28.66%	Est @ -19.45%	Est @ -13.00%	Est @ -8.49%	Est @ -5.33%	Est @ -3.12%	Est @ -1.57%	Est @ -0.49%	Est @ 0.27%
Present Value (CN¥, Millions) Discounted @ 8.0%	CN¥32.1	CN¥21.2	CN¥15.8	CN¥12.7	CN¥10.8	CN¥9.4	CN¥8.5	CN¥7.7	CN¥7.1	CN¥6.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥132m

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 (2.0%) 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 8.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥14m× (1 + 2.0%) ÷ (8.0%– 2.0%) = CN¥243m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥243m÷ ( 1 + 8.0%)¹⁰= CN¥112m

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¥244m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$0.6, the company appears around fair value at the time of writing. 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.

The Assumptions

Now 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 Ronshine Service Holding 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 8.0%, which is based on a levered beta of 1.067. 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 Ronshine Service Holding

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 Ronshine Service Holding, there are three important items you should further examine:

1. Risks: Every company has them, and we've spotted 2 warning signs for Ronshine Service Holding (of which 1 doesn't sit too well with us!) you should know about.
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 Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.