A look at the fair value of Wah Sun Handbags International Holdings Limited (HKG:2683)

Key findings

• Using the 2-step free cash flow to equity, the fair value of Wah Sun Handbags International Holdings is HK$0.51.
• With a share price of HK$0.43, Wah Sun Handbags International Holdings appears to be trading close to its estimated fair value

How far is Wah Sun Handbags International Holdings Limited (HKG:2683) from its intrinsic value? Using the latest financial data, we will check whether the stock is fairly valued by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are relatively easy to follow.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one method. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

View our latest analysis for Wah Sun Handbags International Holdings

The method

We use the 2-stage growth model, which simply means we consider two stages of company growth. In the early stage, the company may have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to get estimates of the next ten years of cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = HK$111 million

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value, which takes into account all future cash flows after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year “growth” period, we discount future cash flows to today’s value, using a cost of equity of 8.5%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$13 million × (1 + 2.2%) ÷ (8.5% – 2.2%) = HK$215 million

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= HK$215 million ÷ ( 1 + 8.5 %)¹⁰= HK$95 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$207 million. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.4, the company appears roughly fairly valued at a 15% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

The assumptions

The above calculation heavily depends on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we are considering Wah Sun Handbags International Holdings as prospective 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 have used 8.5% which is based on a levered beta of 1.156. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0 which is a reasonable range for a stable company.

SWOT Analysis for Wah Sun Handbags International Holdings

Next Steps:

While valuing a company is important, ideally it shouldn’t be the only analysis you look at for a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to be true for this stock to be under/overvalued.” If a company is growing at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome could be very different. For Wah Sun Handbags International Holdings, there are three basic factors you should consider:

1. Risks: Note that Wah Sun Handbags International Holdings shows 3 warning signals in our investment analysis and one of them is a bit uncomfortable…
2. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!
3. Other environmentally friendly companies: Are you concerned about the environment and believe that consumers will increasingly buy environmentally friendly products? Browse through our interactive list of companies thinking about a greener future and discover some stocks you may not have thought of yet!

PS. The Simply Wall St app runs a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment based solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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