Stock Analysis

A Look At The Intrinsic Value Of Kerry Properties Limited (HKG:683)

SEHK:683
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Today we will run through one way of estimating the intrinsic value of Kerry Properties Limited (HKG:683) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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. 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 Kerry Properties

Crunching the numbers

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 start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (HK$, Millions) HK$3.56b HK$4.59b HK$4.18b HK$3.94b HK$3.79b HK$3.71b HK$3.68b HK$3.67b HK$3.68b HK$3.70b
Growth Rate Estimate Source Analyst x2 Analyst x1 Est @ -8.95% Est @ -5.82% Est @ -3.63% Est @ -2.1% Est @ -1.03% Est @ -0.27% Est @ 0.25% Est @ 0.62%
Present Value (HK$, Millions) Discounted @ 11% HK$3.2k HK$3.7k HK$3.0k HK$2.6k HK$2.2k HK$2.0k HK$1.8k HK$1.6k HK$1.4k HK$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$23b

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 (1.5%) 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 11%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK$3.7b× (1 + 1.5%) ÷ (11%– 1.5%) = HK$39b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$39b÷ ( 1 + 11%)10= HK$14b

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$36b. 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$23.5, 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.

dcf
SEHK:683 Discounted Cash Flow July 28th 2021

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Kerry Properties 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 11%, which is based on a levered beta of 1.809. 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.

Moving On:

Whilst important, the DCF calculation 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Kerry Properties, there are three additional elements you should explore:

  1. Risks: For instance, we've identified 1 warning sign for Kerry Properties that you should be aware of.
  2. Future Earnings: How does 683's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  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. 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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