CLP Holdings Limited (HKG:2) Shares Could Be 45% Below Their Intrinsic Value Estimate

Simply Wall St.07-26

Key Insights CLP Holdings' estimated fair value is HK$119 based on 2 Stage Free Cash Flow to Equity CLP Holdings' HK$65.95 share price signals that it might be 45% undervalued The HK$70.29 ...

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One way to achieve this is by employing the Discounted Cash Flow (DCF) model.  Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.  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.  Check out our latest analysis for CLP Holdings  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.  To start off with, we need to estimate 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.   A DCF is all about the idea that a dollar in the future is less valuable than a dollar today,  so we discount the value of these future cash flows to their estimated value in today's dollars:  10-year free cash flow (FCF) forecast  2025 2026 2027 2028 2029 2030 2031 2032 2033 2034  Levered FCF (HK$, Millions)  HK$9.57b HK$10.7b HK$12.3b HK$13.2b HK$14.0b HK$14.6b HK$15.2b HK$15.7b HK$16.1b HK$16.6b Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Analyst x1 Est @ 5.57% Est @ 4.54% Est @ 3.82% Est @ 3.32% Est @ 2.97% Est @ 2.72%  Present Value (HK$, Millions) Discounted @ 6.5%  HK$9.0k HK$9.4k HK$10.1k HK$10.3k HK$10.2k HK$10.0k HK$9.7k HK$9.4k HK$9.1k HK$8.8k (\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$96b We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period.  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 6.5%. Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = HK$17b× (1 + 2.2%) ÷ (6.5%– 2.2%) = HK$386bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$386b÷ ( 1 + 6.5%)10= HK$205b 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$301b.  To get the intrinsic value per share, we divide this by the total number of shares outstanding.  Relative to the current share price of HK$66.0, the company appears   quite good value    at a 45% discount to where the stock price trades currently.   Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. SEHK:2 Discounted Cash Flow July 26th 2024  Important 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 CLP Holdings 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 6.5%, which is based on a levered beta of 0.800. 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 CLP HoldingsStrength Earnings growth over the past year exceeded the industry. Debt is well covered by earnings and cashflows. Balance sheet summary for 2. Weakness Dividend is low compared to the top 25% of dividend payers in the Electric Utilities market.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 Dividends are not covered by earnings. Annual revenue is forecast to grow slower than the Hong Kong market.  See 2's dividend history.  Looking Ahead:  Whilst important, the DCF calculation  shouldn't be the only metric you look at when researching a company.  The DCF model is not a perfect stock valuation tool.  Rather it should be seen as a guide to \"what assumptions need to be true for this stock to be under/overvalued?\"  For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.   Why is the intrinsic value higher than the current share price?   For CLP Holdings, there are three  additional  factors  you should consider:   Risks: For example, we've discovered 3 warning signs for CLP Holdings that you should be aware of before investing here.  Future Earnings: How does 2'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.New: AI Stock Screener & AlertsOur new AI Stock Screener scans the market every day to uncover opportunities.• Dividend Powerhouses (3%+ Yield)• Undervalued Small Caps with Insider Buying• High growth Tech and AI CompaniesOr build your own from over 50 metrics.Explore Now for FreeHave 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.Have feedback on this article? Concerned about the content? Get in touch with us directly. 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