Is There An Opportunity With GCL Technology Holdings Limited's (HKG:3800) 30% Undervaluation?

Key Insights

• GCL Technology Holdings' estimated fair value is HK$1.62 based on 2 Stage Free Cash Flow to Equity
• GCL Technology Holdings' HK$1.14 share price signals that it might be 30% undervalued
• Our fair value estimate is similar to GCL Technology Holdings' analyst price target of CN¥1.62

Today we will run through one way of estimating the intrinsic value of GCL Technology Holdings Limited (HKG:3800) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

Check out our latest analysis for GCL Technology Holdings

Crunching The Numbers

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. 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥2.69b	CN¥3.46b	CN¥3.77b	CN¥4.10b	CN¥4.35b	CN¥4.56b	CN¥4.74b	CN¥4.91b	CN¥5.06b	CN¥5.20b
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x1	Analyst x1	Est @ 6.00%	Est @ 4.84%	Est @ 4.04%	Est @ 3.47%	Est @ 3.07%	Est @ 2.80%
Present Value (CN¥, Millions) Discounted @ 12%	CN¥2.4k	CN¥2.8k	CN¥2.7k	CN¥2.6k	CN¥2.5k	CN¥2.3k	CN¥2.2k	CN¥2.0k	CN¥1.8k	CN¥1.7k

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

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 (2.2%) 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)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥5.2b× (1 + 2.2%) ÷ (12%– 2.2%) = CN¥54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥54b÷ ( 1 + 12%)¹⁰= CN¥18b

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¥41b. 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$1.1, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 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 1.737. 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

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For GCL Technology Holdings, we've put together three additional items you should look at:

1. Risks: Take risks, for example - GCL Technology Holdings has 2 warning signs (and 1 which is a bit concerning) we think you should know about.
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 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. 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.

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