Is There An Opportunity With Central China Real Estate Limited’s (HKG:832) 23.89% Undervaluation?

Lee Kay

Updated Sat, Sep 22, 2018, 8:23 PM

Does the share price for Central China Real Estate Limited (HKG:832) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the expected future cash flows and 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. Please also note that this article was written in September 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Central China Real Estate

Is 832 fairly valued?

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 begin with we have to get estimates of 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 this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF (CN¥, Millions)	CN¥541.00	CN¥1.28k	CN¥1.47k	CN¥1.68k	CN¥1.92k
Source	Analyst x1	Analyst x1	Est @ 14.37%	Est @ 14.37%	Est @ 14.37%
Present Value Discounted @ 17.8%	CN¥459.26	CN¥925.25	CN¥898.30	CN¥872.14	CN¥846.74

Present Value of 5-year Cash Flow (PVCF)= CN¥4.00b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond 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 17.8%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = CN¥1.92b × (1 + 2.2%) ÷ (17.8% – 2.2%) = CN¥12.59b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CN¥12.59b ÷ ( 1 + 17.8%)⁵ = CN¥5.55b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CN¥9.55b. The last step is to then 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) then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of CN¥3.5. However, 832’s primary listing is in China, and 1 share of 832 in CNY represents 1.138 ( CNY/ HKD) share of SEHK:832, so the intrinsic value per share in HKD is HK$3.98. Compared to the current share price of HK$3.03, the stock is about right, perhaps slightly undervalued at a 23.9% discount to what it is available for right now.

SEHK:832 Intrinsic Value Export September 23rd 18

The 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 Central China Real Estate 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 17.8%, which is based on a levered beta of 2. 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. What is the reason for the share price to differ from the intrinsic value? For 832, I’ve compiled three important factors you should look at:

Financial Health: Does 832 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 832’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 832? 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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