In this article we are going to estimate the intrinsic value of Trip.com Group Limited (NASDAQ:TCOM) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Is Trip.com Group 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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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
|Levered FCF (CN¥, Millions)||CN¥7.59b||CN¥8.75b||CN¥9.92b||CN¥10.7b||CN¥11.3b||CN¥11.8b||CN¥12.3b||CN¥12.7b||CN¥13.1b||CN¥13.4b|
|Growth Rate Estimate Source||Analyst x8||Analyst x7||Analyst x2||Est @ 7.52%||Est @ 5.86%||Est @ 4.7%||Est @ 3.89%||Est @ 3.32%||Est @ 2.92%||Est @ 2.64%|
|Present Value (CN¥, Millions) Discounted @ 9.9%||CN¥6.9k||CN¥7.2k||CN¥7.5k||CN¥7.3k||CN¥7.0k||CN¥6.7k||CN¥6.3k||CN¥5.9k||CN¥5.6k||CN¥5.2k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥66b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 9.9%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥13b× (1 + 2.0%) ÷ (9.9%– 2.0%) = CN¥172b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥172b÷ ( 1 + 9.9%)10= CN¥67b
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¥132b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$29.1, the company appears about fair value at a 9.5% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Trip.com Group 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 9.9%, which is based on a levered beta of 1.471. 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.
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for 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. For Trip.com Group, we've put together three pertinent items you should consider:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Trip.com Group (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
- Future Earnings: How does TCOM'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: 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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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.
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