Are Investors Undervaluing East Buy Holding Limited (HKG:1797) By 38%?

Simply Wall St.01-28

Key Insights The projected fair value for East Buy Holding is HK$35.80 based on 2 Stage Free Cash Flow to Equity Current share price of HK$22.20 suggests East Buy Holding is potentially 38% ...

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Using the most recent financial data, we'll take a look at whether the stock is fairly priced  by taking the expected future cash flows and discounting them to today's value.  Our analysis will employ the Discounted Cash Flow (DCF) model.  There's really not all that much to it, even though it might appear quite complex.  We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios.  For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.  View our latest analysis for East Buy Holding  What's The Estimated Valuation?   We're using the 2-stage growth 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 a stable growth rate.  In the first stage we need to estimate the cash flows to the business over the next ten years.   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 companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.   Generally we assume that a dollar today is more valuable than a dollar in the future,  so we need to discount the sum of these future cash flows to arrive at a present value estimate:  10-year free cash flow (FCF) estimate  2024 2025 2026 2027 2028 2029 2030 2031 2032 2033  Levered FCF (CN¥, Millions)  CN¥1.08b CN¥1.25b CN¥1.52b CN¥1.70b CN¥1.86b CN¥1.99b CN¥2.10b CN¥2.20b CN¥2.28b CN¥2.35b Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Est @ 12.42% Est @ 9.28% Est @ 7.09% Est @ 5.55% Est @ 4.48% Est @ 3.73% Est @ 3.20%  Present Value (CN¥, Millions) Discounted @ 7.5%  CN¥1.0k CN¥1.1k CN¥1.2k CN¥1.3k CN¥1.3k CN¥1.3k CN¥1.3k CN¥1.2k CN¥1.2k CN¥1.1k (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = CN¥12b The second stage is also known as Terminal Value, this is the business's cash flow after the first stage.  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 have used the 5-year average of the 10-year government bond yield (2.0%) 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 7.5%. Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥2.4b× (1 + 2.0%) ÷ (7.5%– 2.0%) = CN¥44bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥44b÷ ( 1 + 7.5%)10= CN¥21b The total value, or equity value, is then the sum of the present value of the future cash flows,  which in this case is CN¥33b.  The last step is to then divide the equity value by the number of shares outstanding.  Compared to the current share price of HK$22.2, the company appears   quite good value    at a 38% discount to where the stock price trades currently.   Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind. SEHK:1797 Discounted Cash Flow January 28th 2024  The Assumptions  Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.  Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions.  The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance.  Given that we are looking at East Buy Holding 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 accounts for debt.  In this calculation we've used 7.5%, which is based on a levered beta of 0.905. Beta is a measure of a stock's volatility, compared 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.  SWOT Analysis for East Buy HoldingStrength Currently debt free. Balance sheet summary for 1797. Weakness Earnings growth over the past year underperformed the Consumer Services industry. Opportunity Annual earnings are forecast to grow faster than the Hong Kong market. Trading below our estimate of fair value by more than 20%. Threat Revenue is forecast to grow slower than 20% per year.  What else are analysts forecasting for 1797?  Next Steps:  Valuation is only one side of the coin in terms of building your investment thesis, and it  ideally won't be the sole piece of analysis you scrutinize for a company.  The DCF model is not a perfect stock valuation tool.  Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation.  For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation.   Why is the intrinsic value higher than the current share price?   For East Buy Holding, there are three  essential  elements  you should consider:   Risks: We feel that you should assess the 2 warning signs for East Buy Holding we've flagged before making an investment in the company.  Future Earnings: How does 1797'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!   PS. The Simply Wall St app conducts 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.Valuation is complex, but we're helping make it simple.Find out whether East Buy Holding is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free AnalysisHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. 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