The intrinsic value of Country Garden Services Holdings Company Limited (HKG: 6098) is potentially 52% greater than its share price

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In this article, we’ll estimate the intrinsic value of Country Garden Services Holdings Company Limited (HKG: 6098) by taking the company’s future cash flow forecast and discounting it to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.

We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest review for Country Garden Services Holdings

The method

We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:

10-year Free Cash Flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (CN ¥, Million) CN ¥ 8.38b CN ¥ 10.3b CN ¥ 11.7b CN ¥ 12.8b CN ¥ 13.8b CN ¥ 14.6b CN ¥ 15.2b CN ¥ 15.7b CN ¥ 16.2b CN ¥ 16.6b
Source of estimated growth rate Analyst x4 Analyst x3 East @ 13.56% Est @ 9.94% Is 7.4% Est @ 5.62% East @ 4.38% Is @ 3.51% Is 2.9% East @ 2.47%
Present value (CN ¥, Million) discounted at 7.8% CN ¥ 7.8k CN ¥ 8.8k CN ¥ 9.3k CN ¥ 9.5k CN ¥ 9.5k CN ¥ 9.3k CN ¥ 9.0k CN ¥ 8.6k CN ¥ 8.2k CN ¥ 7.8k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = CN ¥ 88b

It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.5%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.8%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN Â¥ 17b × (1 + 1.5%) ÷ (7.8% – 1.5%) = CN Â¥ 266b

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN ¥ 266b ÷ (1 + 7.8%)ten= CN ¥ 125b

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is CN Â¥ 213b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 52.5, the company looks fairly good value with a 34% 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 this in mind.

SEHK: 6,098 Discounted Cash Flows September 28, 2021

The hypotheses

Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Country Garden Services 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 into account the debt. In this calculation, we used 7.8%, which is based on a leveraged beta of 1.173. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

To move on :

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. The DCF model is not a perfect equity valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Can we understand why the company trades at a discount to its intrinsic value? For Country Garden Services Holdings, there are three basic things you should research further:

  1. Risks: For example, we discovered 3 warning signs for Country Garden Services Holdings which you should know before investing here.
  2. Management: Insiders Have They Raised Their Shares To Take Advantage Of Market Sentiment For The Future Outlook Of 6098? Check out our management and board analysis with information on CEO compensation and governance factors.
  3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, do a search here.

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

Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.

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