Does This Valuation Of FIT Hon Teng Limited (HKG:6088) Imply Investors Are Overpaying?

Key Insights

• FIT Hon Teng's estimated fair value is HK$1.86 based on 2 Stage Free Cash Flow to Equity
• FIT Hon Teng's HK$2.28 share price signals that it might be 23% overvalued
• The US$3.20 analyst price target for 6088 is 72% more than our estimate of fair value

How far off is FIT Hon Teng Limited (HKG:6088) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for FIT Hon Teng

The Method

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$282.0m	US$181.0m	US$151.8m	US$135.7m	US$126.5m	US$121.4m	US$118.7m	US$117.7m	US$117.8m	US$118.7m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -16.14%	Est @ -10.62%	Est @ -6.76%	Est @ -4.06%	Est @ -2.17%	Est @ -0.84%	Est @ 0.09%	Est @ 0.74%
Present Value ($, Millions) Discounted @ 9.4%	US$258	US$151	US$116	US$94.8	US$80.8	US$70.9	US$63.4	US$57.5	US$52.6	US$48.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$994m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$119m× (1 + 2.3%) ÷ (9.4%– 2.3%) = US$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.7b÷ ( 1 + 9.4%)¹⁰= US$697m

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 US$1.7b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$2.3, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 FIT Hon Teng 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 9.4%, which is based on a levered beta of 1.467. 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 FIT Hon Teng

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. What is the reason for the share price exceeding the intrinsic value? For FIT Hon Teng, we've compiled three important elements you should assess:

1. Risks: Every company has them, and we've spotted 2 warning signs for FIT Hon Teng (of which 1 is concerning!) you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 6088'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. 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.