Stock Analysis

# Calculating The Intrinsic Value Of EFT Solutions Holdings Limited (HKG:8062)

Today we will run through one way of estimating the intrinsic value of EFT Solutions Holdings Limited (HKG:8062) 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 would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for EFT Solutions Holdings

### The method

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, 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) estimate

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (HK\$, Millions) HK\$10.1m HK\$10.9m HK\$11.6m HK\$12.1m HK\$12.6m HK\$13.0m HK\$13.3m HK\$13.6m HK\$13.9m HK\$14.2m Growth Rate Estimate Source Est @ 11.08% Est @ 8.21% Est @ 6.2% Est @ 4.79% Est @ 3.81% Est @ 3.12% Est @ 2.64% Est @ 2.3% Est @ 2.06% Est @ 1.9% Present Value (HK\$, Millions) Discounted @ 8.6% HK\$9.3 HK\$9.2 HK\$9.0 HK\$8.7 HK\$8.3 HK\$7.9 HK\$7.5 HK\$7.0 HK\$6.6 HK\$6.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK\$79m

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. 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 8.6%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = HK\$14m× (1 + 1.5%) ÷ (8.6%– 1.5%) = HK\$204m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK\$204m÷ ( 1 + 8.6%)10= HK\$89m

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\$168m. 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\$0.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

### The assumptions

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 EFT Solutions 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 8.6%, which is based on a levered beta of 1.153. 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.

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. For EFT Solutions Holdings, we've put together three additional factors you should consider:

1. Risks: We feel that you should assess the 3 warning signs for EFT Solutions Holdings (1 is a bit concerning!) we've flagged before making an investment in the company.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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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### Valuation is complex, but we're here to simplify it.

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This article by Simply Wall St is general in nature. 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.
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