Excellence Commercial Property & Facilities Management Group Limited's (HKG:6989) Intrinsic Value Is Potentially 24% Below Its Share Price

By
Simply Wall St
Published
May 20, 2021
SEHK:6989
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Excellence Commercial Property & Facilities Management Group Limited (HKG:6989) 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. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Excellence Commercial Property & Facilities Management Group

The calculation

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

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (CN¥, Millions) CN¥458.0m CN¥459.0m CN¥461.7m CN¥465.6m CN¥470.5m CN¥476.0m CN¥482.0m CN¥488.4m CN¥495.1m CN¥502.1m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 0.58% Est @ 0.85% Est @ 1.04% Est @ 1.17% Est @ 1.27% Est @ 1.33% Est @ 1.37% Est @ 1.41%
Present Value (CN¥, Millions) Discounted @ 7.3% CN¥427 CN¥399 CN¥374 CN¥352 CN¥331 CN¥313 CN¥295 CN¥279 CN¥263 CN¥249

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 7.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN¥502m× (1 + 1.5%) ÷ (7.3%– 1.5%) = CN¥8.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥8.8b÷ ( 1 + 7.3%)10= CN¥4.4b

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 CN¥7.7b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$9.9, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
SEHK:6989 Discounted Cash Flow May 21st 2021

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 Excellence Commercial Property & Facilities Management 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 7.3%, which is based on a levered beta of 1.071. 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.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. What is the reason for the share price exceeding the intrinsic value? For Excellence Commercial Property & Facilities Management Group, we've put together three relevant elements you should further research:

  1. Financial Health: Does 6989 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 6989'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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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