An Intrinsic Calculation For Canvest Environmental Protection Group Company Limited (HKG:1381) Shows It’s 29.16% Undervalued

Julian Fleming

Sun, Jan 13, 2019, 9:58 PM

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Canvest Environmental Protection Group Company Limited (HKG:1381) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for Canvest Environmental Protection Group by following the link below.

Check out our latest analysis for Canvest Environmental Protection Group

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What’s the value?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF (HK$, Millions)	HK$-506.35	HK$-540.38	HK$1.12k	HK$816.50	HK$1.17k
Source	Analyst x4	Analyst x3	Analyst x1	Analyst x2	Analyst x2
Present Value Discounted @ 8.44%	HK$-466.94	HK$-459.53	HK$880.65	HK$590.46	HK$781.90

Present Value of 5-year Cash Flow (PVCF)= HK$1.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.2%. We discount this to today’s value at a cost of equity of 8.4%.

Terminal Value (TV) = FCF₂₀₂₃ × (1 + g) ÷ (r – g) = HK$1.2b × (1 + 2.2%) ÷ (8.4% – 2.2%) = HK$19b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = HK$19b ÷ ( 1 + 8.4%)⁵ = HK$13b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is HK$14b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of HK$5.76. Relative to the current share price of HK$4.08, the stock is about right, perhaps slightly undervalued at a 29% discount to what it is available for right now.

SEHK:1381 Intrinsic Value Export January 14th 19

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Canvest Environmental Protection Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.4%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 1381, I’ve put together three pertinent factors you should further examine:

Financial Health: Does 1381 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does 1381’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 1381? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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