Today we are going to walk through a way to estimate the intrinsic value of ANTA Sports Products Limited (HKG:2020) by taking expected future cash flows and discounting them to their present value. One way to do this is to use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
Check opportunities and risks within the luxury industry in Hong Kong.
Step by step through the calculation
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less 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
|Leveraged FCF (CN¥, Million)||CN¥13.4b||CN¥14.7b||CN¥17.6b||CN¥18.6b||CN¥19.3b||CN¥19.9b||CN¥20.5b||CN¥21.0b||CN¥21.4b||CN¥21.8b|
|Growth rate estimate Source||Analyst x13||Analyst x13||Analyst x2||Analyst x2||Is at 3.88%||Is at 3.2%||Is at 2.73%||Is @ 2.4%||Is at 2.16%||East @ 2%|
|Present value (CN¥, million) discounted at 7.6%||CN¥12.4k||CN¥12.7k||CN¥14.2k||CN¥13.9k||CN¥13.4k||CN¥12.8k||CN¥12.3k||CN¥11.7k||CN¥11.1k||CN¥10.5k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥125b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.6%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥22b × (1 + 1.6%) ÷ (7.6%–1.6%) = CN¥372b
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥372b÷ ( 1 + 7.6%)ten= CN¥179b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 304 billion Canadian yen. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK$81.6, the company looks quite undervalued at a 33% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
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 entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider ANTA Sports Products 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 takes debt into account. In this calculation, we used 7.6%, which is based on a leveraged beta of 1.096. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT analysis for ANTA Sports products
- Earnings growth over the past year has exceeded that of the industry.
- Debt is not considered a risk.
- Earnings growth over the past year is below its 5-year average.
- The dividend is low compared to the top 25% of dividend payers in the luxury market.
- Annual earnings are expected to grow faster than the Hong Kong market.
- Trading below our estimate of fair value by more than 20%.
- Turnover should grow by less than 20% per year.
Let’s move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead, the best use of 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, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Can we understand why the company is trading at a discount to its intrinsic value? For ANTA Sports Products, we have put together three fundamental elements that you should evaluate:
- Financial health: does 2020 show a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future earnings: How does the 2020 growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs an updated cash flow assessment for each SEHK stock every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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