Are Investors Undervaluing Wynn Macau, Limited (HKG:1128) By 43%?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Wynn Macau fair value estimate is HK$10.77
• Current share price of HK$6.16 suggests Wynn Macau is potentially 43% undervalued
• Our fair value estimate is 35% higher than Wynn Macau's analyst price target of HK$7.95

Does the December share price for Wynn Macau, Limited (HKG:1128) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

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Crunching The Numbers

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (HK$, Millions)	HK$5.49b	HK$6.15b	HK$6.23b	HK$6.34b	HK$6.47b	HK$6.62b	HK$6.78b	HK$6.96b	HK$7.14b	HK$7.33b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ 1.28%	Est @ 1.74%	Est @ 2.07%	Est @ 2.29%	Est @ 2.45%	Est @ 2.56%	Est @ 2.64%	Est @ 2.69%
Present Value (HK$, Millions) Discounted @ 13%	HK$4.9k	HK$4.8k	HK$4.3k	HK$3.9k	HK$3.5k	HK$3.2k	HK$2.9k	HK$2.6k	HK$2.4k	HK$2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$35b

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 (2.8%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = HK$7.3b× (1 + 2.8%) ÷ (13%– 2.8%) = HK$74b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$74b÷ ( 1 + 13%)¹⁰= HK$22b

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$56b. 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$6.2, the company appears quite good value at a 43% 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.

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 Wynn Macau 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 Wynn Macau

SWOT Analysis for Wynn Macau

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. 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 Wynn Macau, we've put together three relevant factors you should explore:

1. Risks: You should be aware of the 3 warning signs for Wynn Macau (2 are a bit concerning!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does 1128'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 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. 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.

Have 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.