Is There An Opportunity With Greentown Service Group Co Ltd’s (HKG:2869) 34.7% Undervaluation?

Alexis Guardo

Updated Mon, Sep 3, 2018, 10:16 PM

How far off is Greentown Service Group Co Ltd (HKG:2869) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by estimating the company’s future cash flows and discounting them to their present value. This is done using 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 September 2018 then I highly recommend you check out the latest calculation for Greentown Service Group by following the link below.

View our latest analysis for Greentown Service Group

The model

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. 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¥795.25	CN¥999.50	CN¥1.18k	CN¥1.38k	CN¥1.60k
Source	Analyst x4	Analyst x4	Est @ 18%, capped from 25.19%	Est @ 17%, capped from 25.19%	Est @ 16%, capped from 25.19%
Present Value Discounted @ 8.44%	CN¥733.35	CN¥849.96	CN¥924.89	CN¥997.89	CN¥1.07k

Present Value of 5-year Cash Flow (PVCF)= CN¥4.57b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. 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) = CN¥1.60b × (1 + 2.2%) ÷ (8.4% – 2.2%) = CN¥26.23b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = CN¥26.23b ÷ ( 1 + 8.4%)⁵ = CN¥17.49b

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 CN¥22.06b. 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¥7.94. However, 2869’s primary listing is in China, and 1 share of 2869 in CNY represents 1.149 ( CNY/ HKD) share of SEHK:2869, so the intrinsic value per share in HKD is HK$9.13. Compared to the current share price of HK$5.96, the stock is quite undervalued at a 34.7% discount to what it is available for right now.

SEHK:2869 Intrinsic Value Export September 4th 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 Greentown Service Group 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:

Valuation is only one side of the coin in terms of building your investment thesis, and 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 2869, I’ve compiled three fundamental aspects you should look at:

Financial Health: Does 2869 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 2869’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 2869? 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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