The intrinsic value of SITC International Holdings Company Limited (HKG: 1308) is potentially 54% greater than its share price
Today we are going to take a simple overview of a valuation method used to estimate the attractiveness of SITC International Holdings Company Limited (HKG: 1308) as an investment opportunity by taking forecast of future cash flows of the business and discounting them to today’s value. . One way to do this is to use the Discounted Cash Flow (DCF) model. There really isn’t much to it, although it might seem quite complex.
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for SITC International Holdings
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
|Leverage FCF ($, Millions)||US $ 457.0 million||US $ 306.0 million||US $ 655.0 million||US $ 738.0 million||US $ 806.8 million||US $ 863.0 million||US $ 908.9 million||946.8 million US dollars||US $ 978.6 million||US $ 1.01 billion|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||Est @ 12.68%||East @ 9.32%||Est @ 6.97%||East @ 5.32%||East @ 4.17%||East @ 3.36%||East @ 2.8%|
|Present value (in millions of dollars) discounted at 6.6%||$ 429||US $ 270||$ 541||$ 573||US $ 587||590 USD||583 USD||US $ 570||US $ 553||US $ 533|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 5.2 billion
The second stage is also known as terminal value, this is the cash flow of the business after 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 of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 6.6%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 1.0 billion × (1 + 1.5%) ÷ (6.6% – 1.5%) = US $ 20 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 20 billion ÷ (1 + 6.6%)ten= US $ 11 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 16 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK $ 29.9, the company appears to be quite undervalued with a 35% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play 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 view SITC 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 takes into account debt. In this calculation, we used 6.6%, which is based on a leveraged beta of 0.955. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While valuing a business is important, it is only one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Why is intrinsic value greater than the current share price? For SITC International Holdings, we have compiled three additional aspects that you should consider:
- Risks: Concrete example, we have spotted 3 warning signs for SITC International Holdings you must be aware.
- Management: Have Insiders Raised Their Shares To Take Advantage Of Market Sentiment For 1308 Future Outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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