Estimating The Intrinsic Value Of TL Natural Gas Holdings Limited (HKG:8536)

Key Insights

• The projected fair value for TL Natural Gas Holdings is HK$0.19 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.20 suggests TL Natural Gas Holdings is potentially trading close to its fair value
• When compared to theindustry average discount of -2,837%, TL Natural Gas Holdings' competitors seem to be trading at a greater premium to fair value

Today we will run through one way of estimating the intrinsic value of TL Natural Gas Holdings Limited (HKG:8536) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for TL Natural Gas Holdings

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 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥1.83m	CN¥2.02m	CN¥2.17m	CN¥2.30m	CN¥2.41m	CN¥2.50m	CN¥2.58m	CN¥2.66m	CN¥2.72m	CN¥2.78m
Growth Rate Estimate Source	Est @ 13.90%	Est @ 10.27%	Est @ 7.73%	Est @ 5.95%	Est @ 4.70%	Est @ 3.83%	Est @ 3.22%	Est @ 2.80%	Est @ 2.50%	Est @ 2.29%
Present Value (CN¥, Millions) Discounted @ 9.3%	CN¥1.7	CN¥1.7	CN¥1.7	CN¥1.6	CN¥1.5	CN¥1.5	CN¥1.4	CN¥1.3	CN¥1.2	CN¥1.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥15m

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 (1.8%) 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 9.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥2.8m× (1 + 1.8%) ÷ (9.3%– 1.8%) = CN¥38m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥38m÷ ( 1 + 9.3%)¹⁰= CN¥16m

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¥30m. 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$0.2, the company appears around fair value 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.

The Assumptions

Now 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 TL Natural Gas 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 9.3%, which is based on a levered beta of 1.043. 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 TL Natural Gas Holdings

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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. For TL Natural Gas Holdings, there are three relevant items you should further research:

1. Risks: Be aware that TL Natural Gas Holdings is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.