Calculation of the fair value of Century Sunshine Group Holdings Limited (HKG: 509)

Today we are going to walk through one way to estimate the intrinsic value of Century Sunshine Group Holdings Limited (HKG:509) by taking expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.

Check out our latest analysis for Century Sunshine Group Holdings

The calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the business may have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (HK$, Millions) HK$10.1 million HK$12.0 million HK$13.7 million HK$15.1 million HK$16.3 million HK$17.2 million HK$18.0 million HK$18.7 million HK$19.3 million HK$19.7 million
Growth rate estimate Source Is 26.99% East @ 19.36% Is at 14.01% Is at 10.28% Is at 7.66% Is at 5.83% Is at 4.54% Is at 3.64% Is at 3.02% Is at 2.58%
Present value (HK$, millions) discounted at 11% HK$9.1 HK$9.7 HK$10.0 HKD9.9 HK$9.6 HK$9.1 HK$8.6 HK$8.0 HK$7.4 HK$6.8

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = HK$88 million

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount the terminal cash flows to their present value at a cost of equity of 11%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = HK$20 million × (1 + 1.6%) ÷ (11%–1.6%) = HK$207 million

Present value of terminal value (PVTV)= TV / (1 + r)ten= HK$207 million (1+11%)ten= HK$71 million

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is HK$159 million. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.03, the company appears to be about fair value at a 20% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.

SEHK: 509 Discounted Cash Flow August 12, 2022

The hypotheses

Now, 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 these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Century Sunshine Group Holdings as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 11%, which is based on a leveraged beta of 2,000. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While important, calculating DCF shouldn’t be the only metric to consider when researching a business. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Century Sunshine Group Holdings, there are three additional things you should dig into:

  1. Risks: For example, we spotted 4 warning signs for Century Sunshine Group Holdings you should be aware of, and 2 of them should not be ignored.
  2. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
  3. Other environmentally friendly companies: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!

PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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