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Is There An Opportunity With Zhejiang SSAW Boutique Hotels Co.,Ltd's (SZSE:301073) 39% Undervaluation?

Simply Wall St ·  {{timeTz}}

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Zhejiang SSAW Boutique Hotels Co.,Ltd (SZSE:301073) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Zhejiang SSAW Boutique HotelsLtd

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 begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CN¥, Millions) CN¥26.0m CN¥193.0m CN¥284.8m CN¥382.4m CN¥478.0m CN¥566.3m CN¥645.2m CN¥714.4m CN¥775.1m CN¥828.9m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 47.57% Est @ 34.28% Est @ 24.99% Est @ 18.48% Est @ 13.92% Est @ 10.73% Est @ 8.5% Est @ 6.94%
Present Value (CN¥, Millions) Discounted @ 8.6% CN¥23.9 CN¥164 CN¥222 CN¥275 CN¥316 CN¥344 CN¥361 CN¥368 CN¥368 CN¥362

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.8b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (3.3%) 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 8.6%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥829m× (1 + 3.3%) ÷ (8.6%– 3.3%) = CN¥16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥16b÷ ( 1 + 8.6%)10= CN¥7.0b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥9.8b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥74.1, the company appears quite undervalued at a 39% 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.

SZSE:301073 Discounted Cash Flow May 24th 2022

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Zhejiang SSAW Boutique HotelsLtd 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 8.6%, which is based on a levered beta of 1.083. 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.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. What is the reason for the share price sitting below the intrinsic value? For Zhejiang SSAW Boutique HotelsLtd, we've compiled three further aspects you should look at:

  1. Risks: We feel that you should assess the 2 warning signs for Zhejiang SSAW Boutique HotelsLtd (1 is a bit concerning!) we've flagged before making an investment in the company.
  2. Future Earnings: How does 301073'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 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 SZSE 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.

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