Calculating The Intrinsic Value Of Fineland Living Services Group Limited (HKG:9978)

Key Insights

• The projected fair value for Fineland Living Services Group is HK$0.13 based on 2 Stage Free Cash Flow to Equity
• With HK$0.13 share price, Fineland Living Services Group appears to be trading close to its estimated fair value
• Fineland Living Services Group's peers are currently trading at a premium of 26% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Fineland Living Services Group Limited (HKG:9978) as an investment opportunity by projecting its future cash flows and then 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Fineland Living Services Group

Is Fineland Living Services Group 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. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥9.56m	CN¥7.20m	CN¥6.00m	CN¥5.33m	CN¥4.94m	CN¥4.71m	CN¥4.59m	CN¥4.53m	CN¥4.51m	CN¥4.52m
Growth Rate Estimate Source	Est @ -36.01%	Est @ -24.67%	Est @ -16.73%	Est @ -11.17%	Est @ -7.28%	Est @ -4.56%	Est @ -2.65%	Est @ -1.31%	Est @ -0.38%	Est @ 0.27%
Present Value (CN¥, Millions) Discounted @ 12%	CN¥8.6	CN¥5.8	CN¥4.3	CN¥3.4	CN¥2.8	CN¥2.4	CN¥2.1	CN¥1.9	CN¥1.7	CN¥1.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥34m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 12%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥4.5m× (1 + 1.8%) ÷ (12%– 1.8%) = CN¥46m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥46m÷ ( 1 + 12%)¹⁰= CN¥15m

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¥49m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.1, the company appears about fair value at a 6.2% 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

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 Fineland Living Services Group 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 12%, which is based on a levered beta of 1.398. 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 Fineland Living Services Group

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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Fineland Living Services Group, we've compiled three additional aspects you should explore:

1. Risks: We feel that you should assess the 1 warning sign for Fineland Living Services Group we've flagged before making an investment in the company.
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. 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.