Is China Everbright Greentech Limited (HKG:1257) Trading At A 49% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China Everbright Greentech fair value estimate is HK$2.00
• China Everbright Greentech's HK$1.02 share price signals that it might be 49% undervalued
• Analyst price target for 1257 is HK$1.13 which is 44% below our fair value estimate

How far off is China Everbright Greentech Limited (HKG:1257) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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The Model

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 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.

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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (HK$, Millions)	HK$408.1m	HK$425.5m	HK$441.8m	HK$457.4m	HK$472.6m	HK$487.6m	HK$502.5m	HK$517.5m	HK$532.7m	HK$548.2m
Growth Rate Estimate Source	Analyst x1	Est @ 4.26%	Est @ 3.83%	Est @ 3.53%	Est @ 3.32%	Est @ 3.17%	Est @ 3.06%	Est @ 2.99%	Est @ 2.94%	Est @ 2.90%
Present Value (HK$, Millions) Discounted @ 13%	HK$361	HK$333	HK$306	HK$280	HK$256	HK$234	HK$213	HK$194	HK$177	HK$161

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$2.5b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = HK$548m× (1 + 2.8%) ÷ (13%– 2.8%) = HK$5.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$5.5b÷ ( 1 + 13%)¹⁰= HK$1.6b

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$4.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$1.0, the company appears quite good value at a 49% 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 China Everbright Greentech 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 13%, which is based on a levered beta of 2.000. 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.

View our latest analysis for China Everbright Greentech

SWOT Analysis for China Everbright Greentech

Moving On:

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. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For China Everbright Greentech, there are three essential aspects you should look at:

1. Risks: Case in point, we've spotted 2 warning signs for China Everbright Greentech you should be aware of, and 1 of them is a bit unpleasant.
2. Future Earnings: How does 1257'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.
3. 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.

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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.