PAX Global Technology Limited (HKG:327) Shares Could Be 48% Below Their Intrinsic Value Estimate

Simply Wall St.07-03

Key Insights Using the 2 Stage Free Cash Flow to Equity, PAX Global Technology fair value estimate is HK$9.58 Current share price of HK$5.00 suggests PAX Global Technology is potentially 48% ...

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We will use the Discounted Cash Flow (DCF) model on this occasion.  Believe it or not, it's not too difficult to follow, as you'll see from our example!  We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws.  If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.  See our latest analysis for PAX Global Technology  What's The Estimated Valuation?   We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase.  To begin with, we have to get estimates of 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 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,  and so the sum of these future cash flows is then discounted to today's value:  10-year free cash flow (FCF) estimate  2025 2026 2027 2028 2029 2030 2031 2032 2033 2034  Levered FCF (HK$, Millions)  HK$1.20b HK$943.0m HK$802.1m HK$723.4m HK$678.3m HK$653.2m HK$640.4m HK$635.8m HK$636.6m HK$641.4m Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ -14.94% Est @ -9.81% Est @ -6.23% Est @ -3.71% Est @ -1.95% Est @ -0.72% Est @ 0.14% Est @ 0.74%  Present Value (HK$, Millions) Discounted @ 8.1%  HK$1.1k HK$806 HK$634 HK$529 HK$459 HK$408 HK$370 HK$340 HK$315 HK$293 (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$5.3b 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.  The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%. Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = HK$641m× (1 + 2.2%) ÷ (8.1%– 2.2%) = HK$11bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$11b÷ ( 1 + 8.1%)10= HK$5.0b The total value, or equity value, is then the sum of the present value of the future cash flows,  which in this case is HK$10b.  The last step is to then divide the equity value by the number of shares outstanding.  Compared to the current share price of HK$5.0, the company appears   quite undervalued    at a 48% 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:327 Discounted Cash Flow July 2nd 2024  The Assumptions  Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.  You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them.  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 PAX Global Technology 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 8.1%, which is based on a levered beta of 1.093. 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 PAX Global TechnologyStrength Currently debt free. Dividend is in the top 25% of dividend payers in the market.  Dividend information for 327. Weakness Earnings declined over the past year. Opportunity Annual earnings are forecast to grow faster than the Hong Kong market. Good value based on P/E ratio and estimated fair value. Threat Dividends are not covered by cash flow.  See 327's dividend history.  Moving On:  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.  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 PAX Global Technology, we've put together three  fundamental  factors  you should further examine:   Risks: Every company has them, and we've spotted   2 warning signs for PAX Global Technology   (of which 1 is concerning!) you should know about.   Future Earnings: How does 327'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: Do you like a good all-rounder? 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 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 PAX Global Technology 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.Valuation is complex, but we're helping make it simple.Find out whether PAX Global Technology 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. 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