The shares of Haidilao International Holding Ltd. (HKG: 6862) could be 47% below their intrinsic value estimate

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In this article, we are going to estimate the intrinsic value of Haidilao International Holding Ltd. (HKG:6862) by estimating the company’s future cash flows and discounting them to their present 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’re pretty easy to follow.

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

See our latest analysis for Haidilao International Holding

The method

We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-Year Free Cash Flow (FCF) Forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF (CN¥, Million) CN¥4.95b CN¥5.53b CN¥6.23b CN¥6.74b CN¥7.15b CN¥7.49b CN¥7.77b CN¥8.01b CN¥8.21b CN¥8.40b
Growth rate estimate Source Analyst x7 Analyst x7 Analyst x7 Is at 8.11% Is at 6.12% Is at 4.73% Is at 3.75% Is at 3.07% Is at 2.59% Is at 2.26%
Present value (CN¥, million) discounted at 7.1% CN¥4.6k CN¥4.8k CN¥5.1k CN¥5.1k CN¥5.1k CN¥5.0k CN¥4.8k CN¥4.6k CN¥4.4k CN¥4.2k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥48b

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which 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 present value, using a cost of equity of 7.1%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥8.4b × (1 + 1.5%) ÷ (7.1%–1.5%) = CN¥153b

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥153b÷ ( 1 + 7.1%)ten= CN¥77b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 125 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$13.9, the company appears to be a good value with a 47% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

SEHK: 6862 Discounted Cash Flow May 23, 2022

Important assumptions

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. 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 complete picture of a company’s potential performance. Since we consider Haidilao International Holding 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 7.1%, which is based on a leveraged beta of 1.130. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is the stock price below intrinsic value? For Haidilao International Holding, we have put together three essential factors that you should dig deeper into:

  1. Risks: Every business has them, and we’ve spotted 2 warning signs for Haidilao International Holding you should know.
  2. Future earnings: How does the growth rate of 6862 compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. The Simply Wall St app performs an updated cash flow assessment for each SEHK stock every day. If you want to find the calculation for other stocks, 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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