Calculating The Fair Value Of GCL Technology Holdings Limited (HKG:3800)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, GCL Technology Holdings fair value estimate is HK$2.33
• Current share price of HK$1.88 suggests GCL Technology Holdings is potentially trading close to its fair value
• Our fair value estimate is 41% lower than GCL Technology Holdings' analyst price target of CN¥3.98

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of GCL Technology Holdings Limited (HKG:3800) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for GCL Technology Holdings

Is GCL Technology Holdings Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 (CN¥, Millions)	-CN¥3.04b	CN¥2.05b	CN¥3.12b	CN¥4.27b	CN¥5.40b	CN¥6.42b	CN¥7.31b	CN¥8.05b	CN¥8.67b	CN¥9.18b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 51.95%	Est @ 36.89%	Est @ 26.34%	Est @ 18.96%	Est @ 13.80%	Est @ 10.18%	Est @ 7.65%	Est @ 5.88%
Present Value (CN¥, Millions) Discounted @ 12%	-CN¥2.7k	CN¥1.7k	CN¥2.2k	CN¥2.8k	CN¥3.1k	CN¥3.3k	CN¥3.4k	CN¥3.4k	CN¥3.2k	CN¥3.1k

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

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 (1.7%) 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 12%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥9.2b× (1 + 1.7%) ÷ (12%– 1.7%) = CN¥95b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥95b÷ ( 1 + 12%)¹⁰= CN¥32b

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¥55b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$1.9, the company appears about fair value at a 19% discount to where the stock price trades currently. 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 GCL Technology 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 12%, which is based on a levered beta of 1.408. 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 GCL Technology Holdings

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For GCL Technology Holdings, we've put together three important items you should further examine:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with GCL Technology Holdings .
2. Future Earnings: How does 3800'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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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.