Beijing Enterprises Holdings Limited's (HKG:392) Intrinsic Value Is Potentially 25% Above Its Share Price

Key Insights

• Beijing Enterprises Holdings' estimated fair value is HK$43.72 based on Dividend Discount Model
• Current share price of HK$34.88 suggests Beijing Enterprises Holdings is potentially 20% undervalued
• The CN¥35.18 analyst price target for 392 is 20% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Beijing Enterprises Holdings Limited (HKG:392) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Is Beijing Enterprises Holdings Fairly Valued?

We have to calculate the value of Beijing Enterprises Holdings slightly differently to other stocks because it is a gas utilities company. In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.7%. We then discount this figure to today's value at a cost of equity of 6.8%. Relative to the current share price of HK$34.9, the company appears a touch undervalued at a 20% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= CN¥1.6 / (6.8% – 2.7%)

= HK$43.7

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Beijing Enterprises 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 6.8%, 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.

See our latest analysis for Beijing Enterprises Holdings

SWOT Analysis for Beijing Enterprises Holdings

Next Steps:

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. 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. Why is the intrinsic value higher than the current share price? For Beijing Enterprises Holdings, there are three important elements you should look at:

1. Risks: For example, we've discovered 2 warning signs for Beijing Enterprises Holdings (1 is a bit unpleasant!) that you should be aware of before investing here.
2. Future Earnings: How does 392'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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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.