Calculating The Fair Value Of Jy Gas Limited (HKG:1407)

Key Insights

• The projected fair value for Jy Gas is HK$0.56 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$0.59 suggests Jy Gas is potentially trading close to its fair value
• Peers of Jy Gas are currently trading on average at a 49% discount

Today we will run through one way of estimating the intrinsic value of Jy Gas Limited (HKG:1407) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for Jy Gas

Is Jy Gas 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. 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.

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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥21.5m	CN¥17.0m	CN¥14.6m	CN¥13.3m	CN¥12.5m	CN¥12.1m	CN¥11.8m	CN¥11.7m	CN¥11.7m	CN¥11.8m
Growth Rate Estimate Source	Est @ -30.60%	Est @ -20.86%	Est @ -14.04%	Est @ -9.26%	Est @ -5.92%	Est @ -3.58%	Est @ -1.94%	Est @ -0.79%	Est @ 0.01%	Est @ 0.57%
Present Value (CN¥, Millions) Discounted @ 6.7%	CN¥20.2	CN¥15.0	CN¥12.0	CN¥10.2	CN¥9.0	CN¥8.2	CN¥7.5	CN¥7.0	CN¥6.5	CN¥6.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥102m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥12m× (1 + 1.9%) ÷ (6.7%– 1.9%) = CN¥247m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥247m÷ ( 1 + 6.7%)¹⁰= CN¥129m

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¥231m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.6, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Jy Gas 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 6.7%, 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.

Looking Ahead:

Although the valuation of a company is important, 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 Jy Gas, we've compiled three relevant items you should further examine:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Jy Gas .
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.