Calculating The Fair Value Of BII Railway Transportation Technology Holdings Company Limited (HKG:1522)

Key Insights

• BII Railway Transportation Technology Holdings' estimated fair value is HK$0.3 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.4 suggests BII Railway Transportation Technology Holdings is trading close to its fair value
• Industry average of 3,813% suggests BII Railway Transportation Technology Holdings' peers are currently trading at a higher premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of BII Railway Transportation Technology Holdings Company Limited (HKG:1522) 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. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for BII Railway Transportation Technology Holdings

The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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$44.3m	HK$50.1m	HK$54.8m	HK$58.7m	HK$62.0m	HK$64.6m	HK$66.9m	HK$68.9m	HK$70.6m	HK$72.2m
Growth Rate Estimate Source	Est @ 17.74%	Est @ 12.90%	Est @ 9.52%	Est @ 7.15%	Est @ 5.49%	Est @ 4.33%	Est @ 3.52%	Est @ 2.95%	Est @ 2.55%	Est @ 2.27%
Present Value (HK$, Millions) Discounted @ 10%	HK$40.2	HK$41.2	HK$40.9	HK$39.7	HK$38.0	HK$35.9	HK$33.7	HK$31.5	HK$29.3	HK$27.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$357m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$72m× (1 + 1.6%) ÷ (10%– 1.6%) = HK$847m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$847m÷ ( 1 + 10%)¹⁰= HK$318m

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 HK$676m. 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$0.4, the company appears around fair value 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 BII Railway Transportation 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 10%, which is based on a levered beta of 1.238. 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:

Whilst important, the DCF calculation 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For BII Railway Transportation Technology Holdings, we've put together three further factors you should look at:

1. Risks: We feel that you should assess the 4 warning signs for BII Railway Transportation Technology Holdings we've flagged before making an investment in the company.
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. 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.

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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.