China Gas Holdings Limited's (HKG:384) Intrinsic Value Is Potentially 78% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China Gas Holdings fair value estimate is HK$15.22
• Current share price of HK$8.55 suggests China Gas Holdings is potentially 44% undervalued
• Analyst price target for 384 is HK$11.12 which is 27% below our fair value estimate

How far off is China Gas Holdings Limited (HKG:384) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected 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. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for China Gas Holdings

Is China Gas Holdings 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. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$958.0m	HK$2.63b	HK$3.93b	HK$4.32b	HK$5.21b	HK$5.87b	HK$6.43b	HK$6.88b	HK$7.27b	HK$7.59b
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x2	Analyst x1	Analyst x1	Est @ 12.67%	Est @ 9.41%	Est @ 7.12%	Est @ 5.53%	Est @ 4.41%
Present Value (HK$, Millions) Discounted @ 8.4%	HK$884	HK$2.2k	HK$3.1k	HK$3.1k	HK$3.5k	HK$3.6k	HK$3.7k	HK$3.6k	HK$3.5k	HK$3.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$31b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (1.8%) 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$7.6b× (1 + 1.8%) ÷ (8.4%– 1.8%) = HK$117b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$117b÷ ( 1 + 8.4%)¹⁰= HK$52b

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$83b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$8.6, the company appears quite undervalued at a 44% 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.

The 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 China Gas 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 8.4%, which is based on a levered beta of 0.948. 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.

SWOT Analysis for China Gas Holdings

Looking Ahead:

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. The DCF model is not a perfect stock valuation tool. 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. Why is the intrinsic value higher than the current share price? For China Gas Holdings, we've put together three pertinent elements you should further research:

1. Risks: Case in point, we've spotted 2 warning signs for China Gas Holdings you should be aware of, and 1 of them doesn't sit too well with us.
2. Future Earnings: How does 384'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.