How far is Dashan Education Holdings Limited (HKG: 9986) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Patterns like these may seem beyond a layman’s comprehension, but they are easy enough to follow.
We would like to point out that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at the Simply Wall St analysis model.
See our latest analysis for Dashan Education Holdings
We are going to use a two-step DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. First, we need to estimate the cash flow of the business over the next ten years. Since no analysts estimate of free cash flow is available to us, we have extrapolated past free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) estimate
|Leverage FCF (CN ¥, million)||CNY 47.1 million||CNY 40.2 million||CNY 36.3 million||CNY 33.9 million||CNY 32.6 million||CNY 31.8 million||CNY 31.4 million||CNY 31.3 million||CNY 31.3 million||CNY 31.5 million|
|Source of estimated growth rate||Is at -21.54%||Is at -14.64%||Is at -9.8%||Is at -6.42%||Is @ -4.05%||Is at -2.39%||Is at -1.23%||East @ -0.42%||Is 0.15%||Is 0.55%|
|Present value (CN ¥, million) discounted at 6.9%||44.0 CNY||35.2 CNY||29.6 CNY||25.9 CNY||23.3 CNY||21.2 CNY||19.6 CNY||18.3 CNY||17.1 CNY||16.1 CNY|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = CNY 250 million
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 present value, using a cost of equity of 6.9%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN ¥ 31 m × (1 + 1.5%) ÷ (6.9% – 1.5%) = CN ¥ 585 m
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN ¥ 585 m ÷ (1 + 6.9%)ten= 299 million CNY
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is 549 million yen. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 0.8, the company appears to be around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the 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 view Dashan Education 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 debt. In this calculation, we used 6.9%, which is based on a leveraged beta of 1.012. Beta is a measure of the volatility of a stock, relative to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While important, the DCF calculation shouldn’t be the only metric you look at 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 valuation. For Dashan Education Holdings, there are three important things you need to consider:
- Risks: We think you should rate the 4 warning signs for Dashan Education Holdings (1 should not be ignored!) We have reported before making an investment in the business.
- 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 solid trading fundamentals to see if there are other companies you may not have considered!
- Other environmentally friendly companies: Concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies envisioning 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 every day, so if you want to find the intrinsic value of any other stock just search here.
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