Are Investors Undervaluing COSCO SHIPPING Holdings Co., Ltd. (HKG:1919) By 22%?

Key Insights

• The projected fair value for COSCO SHIPPING Holdings is HK$17.81 based on 2 Stage Free Cash Flow to Equity
• COSCO SHIPPING Holdings' HK$13.88 share price signals that it might be 22% undervalued
• The CN¥13.45 analyst price target for 1919 is 25% less than our estimate of fair value

How far off is COSCO SHIPPING Holdings Co., Ltd. (HKG:1919) from its intrinsic value? 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. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. 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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Step By Step Through The Calculation

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. 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 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 (CN¥, Millions)	CN¥24.8b	CN¥19.6b	CN¥16.7b	CN¥15.2b	CN¥14.3b	CN¥13.9b	CN¥13.7b	CN¥13.7b	CN¥13.8b	CN¥14.0b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ -14.42%	Est @ -9.25%	Est @ -5.63%	Est @ -3.09%	Est @ -1.32%	Est @ -0.08%	Est @ 0.79%	Est @ 1.40%
Present Value (CN¥, Millions) Discounted @ 7.9%	CN¥23.0k	CN¥16.8k	CN¥13.3k	CN¥11.2k	CN¥9.8k	CN¥8.8k	CN¥8.1k	CN¥7.5k	CN¥7.0k	CN¥6.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥112b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥14b× (1 + 2.8%) ÷ (7.9%– 2.8%) = CN¥286b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥286b÷ ( 1 + 7.9%)¹⁰= CN¥134b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥247b. 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$13.9, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 COSCO SHIPPING 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 7.9%, which is based on a levered beta of 0.958. 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.

Check out our latest analysis for COSCO SHIPPING Holdings

SWOT Analysis for COSCO SHIPPING Holdings

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. 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?" 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 COSCO SHIPPING Holdings, we've compiled three important factors you should look at:

1. Risks: Every company has them, and we've spotted 2 warning signs for COSCO SHIPPING Holdings (of which 1 is concerning!) you should know about.
2. Future Earnings: How does 1919'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.