Stock Analysis

Calculating The Intrinsic Value Of HRnetGroup Limited (SGX:CHZ)

SGX:CHZ
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Does the November share price for HRnetGroup Limited (SGX:CHZ) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

View our latest analysis for HRnetGroup

Crunching the numbers

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (SGD, Millions) S$43.5m S$49.2m S$40.9m S$36.3m S$33.7m S$32.2m S$31.4m S$31.1m S$31.1m S$31.3m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -16.91% Est @ -11.19% Est @ -7.19% Est @ -4.39% Est @ -2.43% Est @ -1.05% Est @ -0.09% Est @ 0.58%
Present Value (SGD, Millions) Discounted @ 7.7% S$40.4 S$42.4 S$32.7 S$27.0 S$23.2 S$20.6 S$18.7 S$17.2 S$15.9 S$14.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = S$252m

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 (2.2%) 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 7.7%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = S$31m× (1 + 2.2%) ÷ (7.7%– 2.2%) = S$573m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= S$573m÷ ( 1 + 7.7%)10= S$272m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is S$524m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of S$0.5, the company appears about fair value at a 3.4% discount to where the stock price trades currently. 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.

dcf
SGX:CHZ Discounted Cash Flow November 24th 2020

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 HRnetGroup 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 7.7%, which is based on a levered beta of 0.928. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For HRnetGroup, there are three further items you should consider:

  1. Risks: Case in point, we've spotted 1 warning sign for HRnetGroup you should be aware of.
  2. Future Earnings: How does CHZ'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 SGX every day. If you want to find the calculation for other stocks just search here.

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