I am going to run you through how I calculated the intrinsic value of SITC International Holdings Company Limited (HKG:1308) by estimating the company’s future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
|Levered FCF ($, Millions)||$220.00||$252.00||$253.08||$254.17||$255.26|
|Source||Analyst x1||Analyst x1||Est @ 0.43%||Est @ 0.43%||Est @ 0.43%|
|Present Value Discounted @ 8.44%||$202.88||$214.30||$198.47||$183.81||$170.23|
Present Value of 5-year Cash Flow (PVCF)= US$970m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.4%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$255m × (1 + 2.2%) ÷ (8.4% – 2.2%) = US$4.2b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$4.2b ÷ ( 1 + 8.4%)5 = US$2.8b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$3.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value in the company’s reported currency of $1.41. However, 1308’s primary listing is in Hong Kong, and 1 share of 1308 in USD represents 7.821 ( USD/ HKD) share of SEHK:1308, so the intrinsic value per share in HKD is HK$11.02. Compared to the current share price of HK$6.1, the stock is quite undervalued at a 45% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at SITC International Holdings as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
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. What is the reason for the share price to differ from the intrinsic value? For 1308, I’ve put together three fundamental factors you should look at:
- Financial Health: Does 1308 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does 1308’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: Are there other high quality stocks you could be holding instead of 1308? 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 for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.