Is Chow Tai Fook Jewellery Group Limited (HKG:1929) Worth HK$14.0 Based On Its Intrinsic Value?

Does the October share price for Chow Tai Fook Jewellery Group Limited (HKG:1929) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for Chow Tai Fook Jewellery Group

What's The Estimated Valuation?

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. 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$12.3b	HK$6.98b	HK$8.68b	HK$7.72b	HK$7.16b	HK$6.83b	HK$6.64b	HK$6.55b	HK$6.51b	HK$6.52b
Growth Rate Estimate Source	Analyst x6	Analyst x7	Analyst x7	Est @ -11.07%	Est @ -7.26%	Est @ -4.6%	Est @ -2.73%	Est @ -1.43%	Est @ -0.51%	Est @ 0.13%
Present Value (HK$, Millions) Discounted @ 7.1%	HK$11.4k	HK$6.1k	HK$7.1k	HK$5.9k	HK$5.1k	HK$4.5k	HK$4.1k	HK$3.8k	HK$3.5k	HK$3.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$55b

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 (1.6%) 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 7.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$6.5b× (1 + 1.6%) ÷ (7.1%– 1.6%) = HK$120b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$120b÷ ( 1 + 7.1%)¹⁰= HK$60b

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$115b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$14.0, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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 Chow Tai Fook Jewellery 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 7.1%, which is based on a levered beta of 1.035. 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 Chow Tai Fook Jewellery Group

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Chow Tai Fook Jewellery Group, we've put together three pertinent items you should look at:

1. Risks: For example, we've discovered 1 warning sign for Chow Tai Fook Jewellery Group that you should be aware of before investing here.
2. Future Earnings: How does 1929'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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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.