Calculating The Fair Value Of Tong Ren Tang Technologies Co Ltd (HKG:1666)

Simply Wall St.

Sat, Oct 27, 2018, 7:44 PM

In this article I am going to calculate the intrinsic value of Tong Ren Tang Technologies Co Ltd (HKG:1666) by projecting its future cash flows and then discounting them to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Tong Ren Tang Technologies by following the link below.

View our latest analysis for Tong Ren Tang Technologies

Is 1666 fairly valued?

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 start off with we need to estimate the next five years of cash flows. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF (CN¥, Millions)	CN¥680.27	CN¥768.17	CN¥867.44	CN¥979.54	CN¥1.11k
Source	Est @ 12.92%	Est @ 12.92%	Est @ 12.92%	Est @ 12.92%	Est @ 12.92%
Present Value Discounted @ 8.44%	CN¥627.32	CN¥653.25	CN¥680.25	CN¥708.36	CN¥737.64

Present Value of 5-year Cash Flow (PVCF)= CN¥3.4b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.4%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = CN¥1.1b × (1 + 2.2%) ÷ (8.4% – 2.2%) = CN¥18.1b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CN¥18.1b ÷ ( 1 + 8.4%)⁵ = CN¥12.1b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CN¥15.5b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of CN¥12.1. However, 1666’s primary listing is in China, and 1 share of 1666 in CNY represents 1.129 ( CNY/ HKD) share of OTCPK:TGRN.F, so the intrinsic value per share in HKD is HK$13.66. Relative to the current share price of HK$11.08, the stock is about right, perhaps slightly undervalued at a 19% discount to what it is available for right now.

SEHK:1666 Intrinsic Value Export October 28th 18

The assumptions

I’d like to point out that 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Tong Ren Tang Technologies as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on 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. For 1666, I’ve compiled three relevant aspects you should further research:

Financial Health: Does 1666 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does 1666’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: Are there other high quality stocks you could be holding instead of 1666? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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