Estimating The Fair Value Of Ju Teng International Holdings Limited (HKG:3336)Apr 28, 2020
In this article we are going to estimate the intrinsic value of Ju Teng International Holdings Limited (HKG:3336) by estimating the company's future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Ju Teng International Holdings
The calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Levered FCF (HK$, Millions) HK$613.0m HK$219.0m HK$239.0m HK$221.9m HK$211.9m HK$206.1m HK$203.2m HK$202.1m HK$202.3m HK$203.3m Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ -7.14% Est @ -4.54% Est @ -2.71% Est @ -1.43% Est @ -0.54% Est @ 0.09% Est @ 0.53% Present Value (HK$, Millions) Discounted @ 14% HK$539 HK$169 HK$163 HK$133 HK$112 HK$95.5 HK$82.8 HK$72.4 HK$63.7 HK$56.4
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$1.5b
Story continues
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 10-year government bond rate (1.6%) 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 14%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = HK$203m× (1 + 1.6%) ÷ 14%– 1.6%) = HK$1.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$1.7b÷ ( 1 + 14%)10= HK$471m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is HK$2.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$2.0, the company appears about fair value at a 11% 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. SEHK:3336 Intrinsic value April 28th 2020
Important assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Ju Teng International 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 14%, which is based on a levered beta of 2.000. 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:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Ju Teng International Holdings, There are three important factors you should further examine:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Ju Teng International Holdings (at least 1 which doesn't sit too well with us) , and understanding these should be part of your investment process. Future Earnings: How does 3336'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 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. Simply Wall St updates its DCF calculation for every HK stock every day, so if you want to find the intrinsic value of any other stock just search here.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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