Today we will run through one way of estimating the intrinsic value of Kingboard Laminates Holdings Limited (HKG:1888) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Crunching the numbers
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, 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
|Levered FCF (HK$, Millions)||HK$2.56b||HK$2.71b||HK$2.83b||HK$2.93b||HK$3.02b||HK$3.09b||HK$3.16b||HK$3.22b||HK$3.28b||HK$3.34b|
|Growth Rate Estimate Source||Est @ 7.52%||Est @ 5.71%||Est @ 4.44%||Est @ 3.55%||Est @ 2.93%||Est @ 2.49%||Est @ 2.19%||Est @ 1.98%||Est @ 1.83%||Est @ 1.72%|
|Present Value (HK$, Millions) Discounted @ 7.0%||HK$2.4k||HK$2.4k||HK$2.3k||HK$2.2k||HK$2.1k||HK$2.1k||HK$2.0k||HK$1.9k||HK$1.8k||HK$1.7k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$21b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK$3.3b× (1 + 1.5%) ÷ (7.0%– 1.5%) = HK$61b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$61b÷ ( 1 + 7.0%)10= HK$31b
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$52b. 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$12.4, the company appears a touch undervalued at a 25% 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.
We would point out that 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 Kingboard Laminates 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 7.0%, which is based on a levered beta of 1.148. 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.
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Kingboard Laminates Holdings, we've compiled three further aspects you should explore:
- Risks: Take risks, for example - Kingboard Laminates Holdings has 1 warning sign we think you should be aware of.
- Future Earnings: How does 1888'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.
- 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.
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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.
Kingboard Laminates Holdings
Kingboard Laminates Holdings Limited, an investment holding company, manufactures and sells laminates in the People's Republic of China, other Asian countries, Europe, and the United States.
Excellent balance sheet with reasonable growth potential.