Key Insights
- Using the Dividend Discount Model, Tian Lun Gas Holdings fair value estimate is HK$4.93
- With HK$4.74 share price, Tian Lun Gas Holdings appears to be trading close to its estimated fair value
- Peers of Tian Lun Gas Holdings are currently trading on average at a 40% premium
Today we will run through one way of estimating the intrinsic value of Tian Lun Gas Holdings Limited (HKG:1600) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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 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.
Is Tian Lun Gas Holdings Fairly Valued?
As Tian Lun Gas Holdings operates in the gas utilities sector, we need to calculate the intrinsic value slightly differently. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (2.2%). The expected dividend per share is then discounted to today's value at a cost of equity of 6.7%. Relative to the current share price of HK$4.7, the company appears about fair value at a 3.9% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= CN¥0.2 / (6.7% – 2.2%)
= HK$4.9
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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Tian Lun Gas 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 6.7%, which is based on a levered beta of 0.800. 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 Tian Lun Gas Holdings
- Earnings growth over the past year exceeded its 5-year average.
- Dividends are covered by earnings and cash flows.
- Dividend information for 1600.
- Earnings growth over the past year underperformed the Gas Utilities industry.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Gas Utilities market.
- Annual earnings are forecast to grow faster than the Hong Kong market.
- Good value based on P/E ratio and estimated fair value.
- Significant insider buying over the past 3 months.
- Debt is not well covered by operating cash flow.
- Is 1600 well equipped to handle threats?
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. 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 Tian Lun Gas Holdings, we've put together three essential factors you should explore:
- Risks: Case in point, we've spotted 2 warning signs for Tian Lun Gas Holdings you should be aware of, and 1 of them makes us a bit uncomfortable.
- Future Earnings: How does 1600'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.
- 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.
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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.