Key Insights

• China Kepei Education Group's estimated fair value is HK$1.61 based on 2 Stage Free Cash Flow to Equity

• With HK$1.44 share price, China Kepei Education Group appears to be trading close to its estimated fair value

• The CN¥3.57 analyst price target for 1890 is 121% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of China Kepei Education Group Limited (HKG:1890) as an investment opportunity  by taking the expected future cash flows and discounting them to today's value.  Our analysis will employ the Discounted Cash Flow (DCF) model.  Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

The Method

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.   Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.6b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.0%) 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 8.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥201m× (1 + 2.0%) ÷ (8.5%– 2.0%) = CN¥3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥3.2b÷ ( 1 + 8.5%)10= CN¥1.4b

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¥3.0b.  The last step is to then divide the equity value by the number of shares outstanding.  Relative to the current share price of HK$1.4, the company appears   about fair value    at a 11% 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.

SEHK:1890 Discounted Cash Flow February 22nd 2024

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 Kepei Education Group 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 8.5%, which is based on a levered beta of 1.141. 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.

SWOT Analysis for China Kepei Education Group

Strength

• Debt is not viewed as a risk.

• Balance sheet summary for 1890.

Weakness

• Earnings growth over the past year underperformed the Consumer Services industry.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

• Good value based on P/E ratio and estimated fair value.

• Significant insider buying over the past 3 months.

Threat

• Annual earnings are forecast to grow slower than the Hong Kong market.

• What else are analysts forecasting for 1890?

Looking Ahead:

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.  Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation.  For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.  For China Kepei Education Group, we've put together three  further  factors  you should further examine:

1. Financial Health: Does 1890 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1890's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.