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In this article I am going to calculate the intrinsic value of Beijing Enterprises Holdings Limited (HKG:392) by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. 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 the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF (HK$, Millions)||HK$4.35k||HK$4.70k||HK$7.83k||HK$8.14k||HK$8.49k|
|Source||Analyst x4||Analyst x4||Analyst x1||Analyst x1||Analyst x1|
|Present Value Discounted @ 11.59%||HK$3.90k||HK$3.78k||HK$5.64k||HK$5.25k||HK$4.91k|
Present Value of 5-year Cash Flow (PVCF)= HK$23b
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 the GDP. In this case I have used the 10-year government bond rate (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 11.6%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = HK$8.5b × (1 + 2%) ÷ (11.6% – 2%) = HK$90b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = HK$90b ÷ ( 1 + 11.6%)5 = HK$52b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is HK$76b. 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 of HK$59.99. Relative to the current share price of HK$44.6, the stock is about right, perhaps slightly undervalued at a 26% discount to what it is available for right now.
I’d like to point out that 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 my result, have a go at the calculation yourself and play with the assumptions. Because 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 weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.6%, which is based on a levered beta of 1.198. 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.
Whilst important, DCF calculation 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 392, I’ve put together three fundamental factors you should further examine:
- Financial Health: Does 392 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 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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 392? 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 does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock 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 firstname.lastname@example.org.