A Look At The Fair Value Of Shin Hwa World Limited (HKG:582)

Key Insights

• Shin Hwa World's estimated fair value is HK$0.081 based on 2 Stage Free Cash Flow to Equity
• With HK$0.066 share price, Shin Hwa World appears to be trading close to its estimated fair value
• Shin Hwa World's peers are currently trading at a premium of 33% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Shin Hwa World Limited (HKG:582) as an investment opportunity by taking the expected future cash flows and 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.

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 Shin Hwa World

Is Shin Hwa World Fairly Valued?

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 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$80.7m	HK$58.7m	HK$47.8m	HK$41.9m	HK$38.5m	HK$36.5m	HK$35.4m	HK$34.8m	HK$34.7m	HK$34.7m
Growth Rate Estimate Source	Est @ -39.79%	Est @ -27.29%	Est @ -18.54%	Est @ -12.41%	Est @ -8.12%	Est @ -5.12%	Est @ -3.02%	Est @ -1.55%	Est @ -0.52%	Est @ 0.20%
Present Value (HK$, Millions) Discounted @ 14%	HK$71.0	HK$45.4	HK$32.5	HK$25.0	HK$20.2	HK$16.9	HK$14.4	HK$12.5	HK$10.9	HK$9.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$258m

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. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$35m× (1 + 1.9%) ÷ (14%– 1.9%) = HK$299m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$299m÷ ( 1 + 14%)¹⁰= HK$83m

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$341m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.07, the company appears about fair value at a 18% 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.

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 Shin Hwa World 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 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 Shin Hwa World

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Shin Hwa World, we've compiled three relevant factors you should further research:

1. Risks: We feel that you should assess the 3 warning signs for Shin Hwa World (1 is potentially serious!) we've flagged before making an investment in the company.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 582's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.