Key Insights

• The projected fair value for China Merchants Port Holdings is HK$13.57 based on 2 Stage Free Cash Flow to Equity

• China Merchants Port Holdings' HK$9.74 share price signals that it might be 28% undervalued

• Analyst price target for 144 is HK$12.08 which is 11% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of China Merchants Port Holdings Company Limited (HKG:144) by projecting its future cash flows and then 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation.  If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

The Method

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.  In the first stage we need to estimate the cash flows to the business over the next ten years.   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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$33b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period.  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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = HK$6.2b× (1 + 2.0%) ÷ (11%– 2.0%) = HK$69b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$69b÷ ( 1 + 11%)10= HK$24b

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 HK$57b.  In the final step we divide the equity value by the number of shares outstanding.  Relative to the current share price of HK$9.7, the company appears   a touch undervalued    at a 28% discount to where the stock price trades currently.   Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

SEHK:144 Discounted Cash Flow February 27th 2024

The Assumptions

We would point out that 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 China Merchants Port 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 11%, which is based on a levered beta of 1.693. 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 Merchants Port Holdings

Strength

• Debt is well covered by cash flow.

• Dividends are covered by earnings and cash flows.

• Dividend is in the top 25% of dividend payers in the market.

• Dividend information for 144.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

• Shareholders have been diluted in the past year.

Opportunity

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

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

Threat

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

• What else are analysts forecasting for 144?

Moving On:

Whilst important, the DCF calculation  ideally won't be the sole piece of analysis you scrutinize for a company.  DCF models are not the be-all and end-all of investment valuation.  Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?"  For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.   Why is the intrinsic value higher than the current share price?   For China Merchants Port Holdings, there are three  essential  items  you should explore:

1. Risks: To that end, you should be aware of the   2 warning signs we've spotted with China Merchants Port Holdings .

2. Future Earnings: How does 144'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. 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.