Calculating The Intrinsic Value Of Asia Resources Holdings Limited (HKG:899)

Key Insights

• Asia Resources Holdings' estimated fair value is HK$0.10 based on 2 Stage Free Cash Flow to Equity
• With HK$0.10 share price, Asia Resources Holdings appears to be trading close to its estimated fair value
• Asia Resources Holdings' peers are currently trading at a premium of 36% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Asia Resources Holdings Limited (HKG:899) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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

The Model

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$6.49m	HK$6.83m	HK$7.11m	HK$7.36m	HK$7.58m	HK$7.78m	HK$7.96m	HK$8.14m	HK$8.31m	HK$8.48m
Growth Rate Estimate Source	Est @ 6.71%	Est @ 5.24%	Est @ 4.21%	Est @ 3.49%	Est @ 2.98%	Est @ 2.63%	Est @ 2.38%	Est @ 2.20%	Est @ 2.08%	Est @ 2.00%
Present Value (HK$, Millions) Discounted @ 9.2%	HK$5.9	HK$5.7	HK$5.5	HK$5.2	HK$4.9	HK$4.6	HK$4.3	HK$4.0	HK$3.8	HK$3.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$47m

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 9.2%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$8.5m× (1 + 1.8%) ÷ (9.2%– 1.8%) = HK$116m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$116m÷ ( 1 + 9.2%)¹⁰= HK$48m

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$96m. 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$0.1, the company appears about fair value at a 1.8% 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

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Asia Resources 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 9.2%, which is based on a levered beta of 1.064. 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 Asia Resources Holdings

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Asia Resources Holdings, we've put together three important aspects you should explore:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 5 warning signs with Asia Resources Holdings (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.