Calculating The Intrinsic Value Of China Foods Limited (HKG:506)

Simply Wall St.

Sun, Oct 28, 2018, 7:17 PM

I am going to run you through how I calculated the intrinsic value of China Foods Limited (HKG:506) by taking the expected future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in 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 China Foods by following the link below.

View our latest analysis for China Foods

The model

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF (CN¥, Millions)	CN¥1.17k	CN¥754.97	CN¥935.14	CN¥972.80	CN¥833.81
Source	Analyst x1	Analyst x2	Analyst x1	Analyst x1	Est @ -14.29%
Present Value Discounted @ 10.25%	CN¥1.06k	CN¥621.10	CN¥697.79	CN¥658.40	CN¥511.86

Present Value of 5-year Cash Flow (PVCF)= CN¥3.6b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. 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 10.3%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = CN¥834m × (1 + 2.2%) ÷ (10.3% – 2.2%) = CN¥10.6b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CN¥10.6b ÷ ( 1 + 10.3%)⁵ = CN¥6.5b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CN¥10.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value in the company’s reported currency of CN¥3.59. However, 506’s primary listing is in Hong Kong, and 1 share of 506 in CNY represents 1.129 ( CNY/ HKD) share of DB:CFH, so the intrinsic value per share in HKD is HK$4.06. Relative to the current share price of HK$3.47, the stock is about right, perhaps slightly undervalued at a 14% discount to what it is available for right now.

SEHK:506 Intrinsic Value Export October 29th 18

Important assumptions

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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at China Foods 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 10.3%, which is based on a levered beta of 1.032. 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:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For 506, there are three pertinent aspects you should further examine:

Financial Health: Does 506 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 506’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 506? 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 for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks 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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