Estimating The Intrinsic Value Of Hutchison Telecommunications Hong Kong Holdings Limited (HKG:215)

Today we will run through one way of estimating the intrinsic value of Hutchison Telecommunications Hong Kong Holdings Limited (HKG:215) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Hutchison Telecommunications Hong Kong Holdings

The calculation

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. To begin with, we have to get estimates of the next ten years of cash flows. 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 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$1.88b	HK$904.0m	HK$498.7m	HK$344.5m	HK$271.4m	HK$232.4m	HK$210.0m	HK$196.9m	HK$189.1m	HK$184.7m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ -44.83%	Est @ -30.93%	Est @ -21.2%	Est @ -14.39%	Est @ -9.62%	Est @ -6.28%	Est @ -3.94%	Est @ -2.31%
Present Value (HK$, Millions) Discounted @ 6.4%	HK$1.8k	HK$798	HK$414	HK$269	HK$199	HK$160	HK$136	HK$120	HK$108	HK$99.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$4.1b

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 6.4%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = HK$185m× (1 + 1.5%) ÷ (6.4%– 1.5%) = HK$3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$3.8b÷ ( 1 + 6.4%)¹⁰= HK$2.1b

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$6.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$1.3, the company appears about fair value at a 1.0% 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.

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Hutchison Telecommunications Hong Kong 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 6.4%, which is based on a levered beta of 0.800. 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.

Moving On:

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Hutchison Telecommunications Hong Kong Holdings, we've put together three further aspects you should consider:

1. Risks: Be aware that Hutchison Telecommunications Hong Kong Holdings is showing 2 warning signs in our investment analysis , and 1 of those is concerning...
2. Future Earnings: How does 215'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.
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. 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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