Estimating The Fair Value Of Kinetix Systems Holdings Limited (HKG:8606)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Kinetix Systems Holdings fair value estimate is HK$0.17
• With HK$0.15 share price, Kinetix Systems Holdings appears to be trading close to its estimated fair value
• Peers of Kinetix Systems Holdings are currently trading on average at a 15% premium

Today we will run through one way of estimating the intrinsic value of Kinetix Systems Holdings Limited (HKG:8606) 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. 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.

See our latest analysis for Kinetix Systems 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 start off with, we need to estimate 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$8.49m	HK$11.5m	HK$14.4m	HK$17.1m	HK$19.4m	HK$21.3m	HK$22.9m	HK$24.2m	HK$25.3m	HK$26.2m
Growth Rate Estimate Source	Est @ 50.05%	Est @ 35.56%	Est @ 25.41%	Est @ 18.31%	Est @ 13.34%	Est @ 9.86%	Est @ 7.42%	Est @ 5.72%	Est @ 4.53%	Est @ 3.69%
Present Value (HK$, Millions) Discounted @ 9.5%	HK$7.8	HK$9.6	HK$11.0	HK$11.9	HK$12.3	HK$12.3	HK$12.1	HK$11.7	HK$11.1	HK$10.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$110m

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 (1.7%) 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 9.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$26m× (1 + 1.7%) ÷ (9.5%– 1.7%) = HK$342m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$342m÷ ( 1 + 9.5%)¹⁰= HK$138m

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$248m. 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$0.1, the company appears about fair value at a 13% 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.

Important 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 Kinetix Systems 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 9.5%, which is based on a levered beta of 1.117. 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 Kinetix Systems Holdings

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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 Kinetix Systems Holdings, there are three additional factors you should assess:

1. Risks: Every company has them, and we've spotted 4 warning signs for Kinetix Systems Holdings (of which 2 don't sit too well with us!) you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 8606's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.