The intrinsic value of Want Want China Holdings Limited (HKG:151) may be 86% above the share price

Key findings

• The estimated fair value of Want Want China Holdings is HK$9.13 based on the 2-step free cash flow to equity
• Want Want China Holdings is estimated to be 46% undervalued based on the current share price of HK$4.90
• The analyst price target of CN¥5.55 for 151 is 39% below our fair value estimate

How far is Want Want China Holdings Limited (HKG:151) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by taking the expected future cash flows and discounting them to their present value. Our analysis will use the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Want Want China Holdings

The calculation

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren’t available, we extrapolate the previous free cash flow (FCF) from the last estimate or 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 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:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 35 billion CNY

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 6.5%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥5.3b × (1 + 2.2%) ÷ (6.5% – 2.2%) = CN¥123b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥123b÷ ( 1 + 6.5 %)¹⁰= 65 billion CNY

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is CN¥100 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$4.9, the company seems to have quite good value for money at a 46% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this as a rough estimate that is not accurate to the last cent.

The assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual 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 consider Want Want China 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 used 6.5%, which is based on a leveraged beta of 0.800. 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 Want Want China Holdings

Next Steps:

While valuing a company is important, ideally it shouldn’t be the only analysis you look at for a company. DCF models aren’t the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. For example, slightly adjusting the terminal value growth rate can dramatically change the overall result. Why is the intrinsic value higher than the current share price? For Want Want China Holdings, there are three fundamental aspects you should examine in more detail:

1. Risks: We think you should 1 warning signal for Want Want China Holdings We indicated this before investing in the company.
2. Future income: How does 151’s growth rate compare to its peers and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. 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!

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 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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