Investors Are Undervaluing Pacific Textiles Holdings Limited (HKG:1382) By 35.45%

Declan Brown

Updated Mon, Jun 25, 2018, 7:15 PM

In this article I am going to calculate the intrinsic value of Pacific Textiles Holdings Limited (HKG:1382) by estimating the company’s 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 June 2018 then I highly recommend you check out the latest calculation for Pacific Textiles Holdings by following the link below. Check out our latest analysis for Pacific Textiles Holdings

What’s the value?

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. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. 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

2018	2019	2020	2021	2022
Levered FCF (HK$, Millions)	HK$752.00	HK$954.00	HK$950.00	HK$1.03k	HK$980.56
Source	Analyst x1	Analyst x1	Analyst x1	Analyst x1	Extrapolated @ (-4.98%)
Present Value Discounted @ 8.44%	HK$693.47	HK$811.27	HK$744.99	HK$746.30	HK$653.90

Present Value of 5-year Cash Flow (PVCF)= HK$3.65b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.2%. We discount this to today’s value at a cost of equity of 8.4%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = HK$980.56m × (1 + 2.2%) ÷ (8.4% – 2.2%) = HK$16.07b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = HK$16.07b ÷ ( 1 + 8.4%)⁵ = HK$10.71b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is HK$14.36b. 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 of HK$9.93. Relative to the current share price of HK$6.41, the stock is quite undervalued at a 35.45% discount to what it is available for right now.

Important 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 Pacific Textiles Holdings 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:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 1382, there are three relevant factors you should further examine:

Financial Health: Does 1382 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 1382’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 1382? 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 pass 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.

Terms and Privacy Policy

Your Privacy Choices

Utah Privacy Notice

More Info