Calculating The Fair Value Of Daisho Microline Holdings Limited (HKG:567)

Key Insights

• The projected fair value for Daisho Microline Holdings is HK$0.074 based on 2 Stage Free Cash Flow to Equity
• With HK$0.085 share price, Daisho Microline Holdings appears to be trading close to its estimated fair value
• Daisho Microline Holdings' peers are currently trading at a discount of 19% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Daisho Microline Holdings Limited (HKG:567) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Daisho Microline Holdings

The Calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$6.40m	HK$6.93m	HK$7.37m	HK$7.74m	HK$8.06m	HK$8.34m	HK$8.59m	HK$8.82m	HK$9.04m	HK$9.25m
Growth Rate Estimate Source	Est @ 10.93%	Est @ 8.24%	Est @ 6.36%	Est @ 5.04%	Est @ 4.12%	Est @ 3.48%	Est @ 3.02%	Est @ 2.71%	Est @ 2.49%	Est @ 2.33%
Present Value (HK$, Millions) Discounted @ 8.3%	HK$5.9	HK$5.9	HK$5.8	HK$5.6	HK$5.4	HK$5.2	HK$4.9	HK$4.7	HK$4.4	HK$4.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$52m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$9.3m× (1 + 2.0%) ÷ (8.3%– 2.0%) = HK$149m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$149m÷ ( 1 + 8.3%)¹⁰= HK$67m

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$119m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.09, the company appears around fair value at the time of writing. 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

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 Daisho Microline 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 8.3%, which is based on a levered beta of 1.071. 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 Daisho Microline Holdings

Looking Ahead:

Although the valuation of a company is important, it 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Daisho Microline Holdings, we've compiled three important elements you should assess:

1. Risks: For example, we've discovered 2 warning signs for Daisho Microline Holdings (1 is a bit unpleasant!) that you should be aware of before investing here.
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. 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.