Today we will run through one way of estimating the intrinsic value of Beijing Capital International Airport Company Limited (HKG:694) by estimating the company's 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Is Beijing Capital International Airport fairly valued?
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.
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
|Levered FCF (CN¥, Millions)||CN¥1.01b||CN¥1.75b||CN¥1.86b||CN¥1.78b||CN¥1.75b||CN¥1.73b||CN¥1.73b||CN¥1.73b||CN¥1.75b||CN¥1.76b|
|Growth Rate Estimate Source||Analyst x5||Analyst x5||Analyst x1||Analyst x1||Est @ -2.05%||Est @ -0.94%||Est @ -0.17%||Est @ 0.37%||Est @ 0.75%||Est @ 1.02%|
|Present Value (CN¥, Millions) Discounted @ 9.0%||CN¥931||CN¥1.5k||CN¥1.4k||CN¥1.3k||CN¥1.1k||CN¥1.0k||CN¥947||CN¥872||CN¥807||CN¥748|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥11b
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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN¥1.8b× (1 + 1.6%) ÷ (9.0%– 1.6%) = CN¥24b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥24b÷ ( 1 + 9.0%)10= CN¥10b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥21b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$6.1, 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 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 Beijing Capital International Airport 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 9.0%, which is based on a levered beta of 1.003. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Beijing Capital International Airport, we've put together three important elements you should assess:
- Risks: Case in point, we've spotted 1 warning sign for Beijing Capital International Airport you should be aware of.
- Future Earnings: How does 694'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: 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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