How far off is Johnson Electric Holdings Limited (SEHK:179) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced using the discounted cash flows (DCF) model. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in December 2017 so be sure check the latest calculation for Johnson Electric Holdings here.
What’s the value?
We are going to use a two-stage DCF model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. Firstly, I use the analyst consensus forecast of 179’s levered free cash flow (FCF) over the next five years and discounted these values at the rate of 8.54%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of $863.4M. Keen to understand how I calculated this value? Read our detailed analysis here.
Above is a visual representation of how 179’s earnings are expected to move in the future, which should give you an idea of 179’s outlook. Then, I calculate the terminal value, which is the business’s cash flow after the first stage. I think it’s suitable to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of $3,921.5M.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is $4,784.9M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of HK$43.31, which, compared to the current share price of HK$30.8, we find that Johnson Electric Holdings is about right, perhaps slightly undervalued at a 28.89% discount to what it is available for right now.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 179, there are three important factors you should look at: