Calculation of the fair value of Powerlong Real Estate Holdings Limited (HKG:1238)
Does the April share price for Powerlong Real Estate Holdings Limited (HKG:1238) reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Powerlong Real Estate Holdings
The method
We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more 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
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (CN¥, Million) | CN¥4.26b | CN¥2.09b | CN¥1.18b | CN¥826.2m | 656.2 million Canadian yen | 564.6 million Canadian yen | CN¥512.0m | 480.8 million Canadian yen | 462.5 million Canadian yen | 452.2 million Canadian yen |
Growth rate estimate Source | Analyst x4 | Analyst x3 | Is @ -43.53% | Is @ -30.03% | East @ -20.58% | East @ -13.96% | Is @ -9.33% | East @ -6.09% | Is @ -3.82% | Is @ -2.23% |
Present value (CN¥, million) discounted at 11% | CN¥3.8k | CN¥1.7k | CN¥855 | CN¥537 | CN¥383 | CN¥296 | CN¥241 | CN¥203 | CN¥176 | CN¥154 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥8.4b
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.5%. We discount terminal cash flows to present value at a cost of equity of 11%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = CN¥452m × (1 + 1.5%) ÷ (11%– 1.5%) = CN¥4.6b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= CN¥4.6b÷ ( 1 + 11%)^{ten}= CN¥1.6b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 9.9 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$2.9, the company appears to be about fair value at a 2.9% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Powerlong Real Estate 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 takes debt into account. In this calculation, we used 11%, which is based on a leveraged beta of 2,000. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Look forward:
Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must 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, output may be very different. For Powerlong Real Estate Holdings, we’ve compiled three fundamentals you should consider:
- Risks: For example, we have identified 5 warning signs for Powerlong Real Estate Holdings (2 are potentially serious) of which you should be aware.
- Future earnings: How does the growth rate of 1238 compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs an updated cash flow valuation for each SEHK stock every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.