Calculating The Fair Value Of Chinlink International Holdings Limited (HKG:997)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Chinlink International Holdings fair value estimate is HK$0.038
• Chinlink International Holdings' HK$0.038 share price indicates it is trading at similar levels as its fair value estimate
• Chinlink International Holdings' peers seem to be trading at a higher premium to fair value based onthe industry average of -143%

Today we will run through one way of estimating the intrinsic value of Chinlink International Holdings Limited (HKG:997) 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

The Calculation

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (HK$, Millions)	HK$4.46m	HK$4.62m	HK$4.76m	HK$4.91m	HK$5.06m	HK$5.21m	HK$5.36m	HK$5.52m	HK$5.67m	HK$5.84m
Growth Rate Estimate Source	Est @ 3.62%	Est @ 3.38%	Est @ 3.21%	Est @ 3.10%	Est @ 3.01%	Est @ 2.96%	Est @ 2.91%	Est @ 2.89%	Est @ 2.87%	Est @ 2.85%
Present Value (HK$, Millions) Discounted @ 13%	HK$4.0	HK$3.6	HK$3.3	HK$3.0	HK$2.7	HK$2.5	HK$2.3	HK$2.1	HK$1.9	HK$1.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$27m

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = HK$5.8m× (1 + 2.8%) ÷ (13%– 2.8%) = HK$59m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$59m÷ ( 1 + 13%)¹⁰= HK$17m

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$44m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.04, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The 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. 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 Chinlink International 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 13%, 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.

View our latest analysis for Chinlink International Holdings

SWOT Analysis for Chinlink International 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. The DCF model is not a perfect stock valuation tool. 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 Chinlink International Holdings, we've put together three additional elements you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Chinlink International Holdings (at least 2 which are significant) , 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 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.

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.