Is Wharf Real Estate Investment Company Limited (HKG:1997) Trading At A 30% Discount?

Simply Wall St.02-20

Key Insights Wharf Real Estate Investment's estimated fair value is HK$36.53 based on 2 Stage Free Cash Flow to Equity Current share price of HK$25.40 suggests Wharf Real Estate Investment is ...

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Using the most recent financial data, we'll take a look at whether the stock is fairly priced  by estimating the company's future cash flows and discounting them to their present value.  This will be done using the Discounted Cash Flow (DCF) model.  Don't get put off by the jargon, the math behind it is actually quite straightforward.  Remember though, that there are many ways to estimate a company's value, and a DCF is just one method.  Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.  View our latest analysis for Wharf Real Estate Investment  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) forecast  2024 2025 2026 2027 2028 2029 2030 2031 2032 2033  Levered FCF (HK$, Millions)  HK$6.86b HK$7.68b HK$8.14b HK$8.54b HK$8.88b HK$9.18b HK$9.45b HK$9.71b HK$9.95b HK$10.2b Growth Rate Estimate Source Analyst x3 Analyst x3 Est @ 6.02% Est @ 4.83% Est @ 3.99% Est @ 3.40% Est @ 3.00% Est @ 2.71% Est @ 2.51% Est @ 2.37%  Present Value (HK$, Millions) Discounted @ 9.5%  HK$6.3k HK$6.4k HK$6.2k HK$5.9k HK$5.7k HK$5.3k HK$5.0k HK$4.7k HK$4.4k HK$4.1k (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$54b After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 9.5%. Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = HK$10b× (1 + 2.0%) ÷ (9.5%– 2.0%) = HK$140bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$140b÷ ( 1 + 9.5%)10= HK$57b The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value,  which in this case is HK$111b.  The last step is to then divide the equity value by the number of shares outstanding.  Relative to the current share price of HK$25.4, the company appears   quite undervalued    at a 30% 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:1997 Discounted Cash Flow February 20th 2024  Important Assumptions  The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows.  If you don't agree with these result, have a go at the calculation yourself and play with the 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 Wharf Real Estate Investment 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 9.5%, which is based on a levered beta of 1.353. 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 Wharf Real Estate InvestmentStrength Debt is well covered by earnings. Balance sheet summary for 1997. WeaknessDividend is low compared to the top 25% of dividend payers in the Real Estate market.Opportunity Expected to breakeven next year. Has sufficient cash runway for more than 3 years based on current free cash flows. Trading below our estimate of fair value by more than 20%. ThreatDebt is not well covered by operating cash flow. Paying a dividend but company is unprofitable. Is 1997 well equipped to handle threats?  Next Steps:  Valuation is only one side of the coin in terms of building your investment thesis, and it  is only one of many factors that you need to assess 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.  If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different.   Can we work out why the company is trading at a discount to intrinsic value?   For Wharf Real Estate Investment, we've compiled three  further  factors  you should further examine:   Risks: Every company has them, and we've spotted   1 warning sign for Wharf Real Estate Investment   you should know about.   Future Earnings: How does 1997'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. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.Valuation is complex, but we're helping make it simple.Find out whether Wharf Real Estate Investment 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. Simply Wall St has no position in any stocks mentioned.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2412448601"}