Does OOH Holdings Limited (HKG:8091) stock price in January reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the 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. This may sound complicated, but it’s actually quite simple!
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for OOH Holdings
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. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimates of free cash flow are available to us, we have extrapolated the previous free cash flow (FCF) from the company’s latest 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (HK$, Millions)||HK$3.48 million||HK$3.36 million||HK$3.29 million||HK$3.25 million||HK$3.24 million||HK$3.25 million||HK$3.27 million||HK$3.30 million||HK$3.34 million||HK$3.38 million|
|Growth rate estimate Source||Is @ -5.77%||Is @ -3.6%||East @ -2.07%||Is @ -1.01%||East @ -0.26%||Is at 0.26%||Is at 0.63%||Is at 0.88%||Is at 1.06%||Is at 1.19%|
|Present value (HK$, millions) discounted at 6.3%||HK$3.3||HK$3.0||HK$2.7||HK$2.5||HK$2.4||HK$2.3||HK$2.1||HK$2.0||HK$1.9||HK$1.8|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = HK$24 million
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.5%. We discount terminal cash flows to present value at a cost of equity of 6.3%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK$3.4 million × (1 + 1.5%) ÷ (6.3%–1.5%) = HK$71 million Kong
Present value of terminal value (PVTV)= TV / (1 + r)ten= HK$71 million÷ (1 + 6.3%)ten= HK$39 million
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 HK$63 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Against the current share price of HK$0.09, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider OOH 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 takes debt into account. In this calculation, we used 6.3%, which is based on a leveraged beta of 0.986. 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.
Valuation is only one side of the coin in terms of crafting your investment thesis, and ideally it won’t be the only piece of analysis you look at 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. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For OOH Holdings, we’ve compiled three important things you should consider:
- Risks: For example, we discovered 3 warning signs for OOH Holdings (2 are potentially serious!) which you should be aware of before investing here.
- 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!
- Other environmentally friendly businesses: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!
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.