Calculating The Fair Value Of China Beidahuang Industry Group Holdings Limited (HKG:39)

Today we will run through one way of estimating the intrinsic value of China Beidahuang Industry Group Holdings Limited (HKG:39) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for China Beidahuang Industry Group Holdings

The model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (HK$, Millions)	HK$48.4m	HK$45.8m	HK$44.3m	HK$43.4m	HK$43.1m	HK$43.0m	HK$43.2m	HK$43.5m	HK$43.9m	HK$44.4m
Growth Rate Estimate Source	Est @ -8.31%	Est @ -5.37%	Est @ -3.3%	Est @ -1.86%	Est @ -0.85%	Est @ -0.14%	Est @ 0.35%	Est @ 0.7%	Est @ 0.94%	Est @ 1.11%
Present Value (HK$, Millions) Discounted @ 14%	HK$42.5	HK$35.4	HK$30.1	HK$25.9	HK$22.6	HK$19.9	HK$17.5	HK$15.5	HK$13.8	HK$12.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$235m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = HK$44m× (1 + 1.5%) ÷ (14%– 1.5%) = HK$368m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$368m÷ ( 1 + 14%)¹⁰= HK$101m

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$336m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$0.05, the company appears about fair value at a 5.6% discount to where the stock price trades currently. 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.

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. 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 China Beidahuang Industry Group 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 14%, 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.

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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For China Beidahuang Industry Group Holdings, we've put together three fundamental factors you should further examine:

1. Risks: Be aware that China Beidahuang Industry Group Holdings is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
2. 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!
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.

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This article by Simply Wall St is general in nature. 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.
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