Is There An Opportunity With Tsingtao Brewery Company Limited's (HKG:168) 41% Undervaluation?

Key Insights

• The projected fair value for Tsingtao Brewery is HK$93.48 based on 2 Stage Free Cash Flow to Equity
• Tsingtao Brewery is estimated to be 41% undervalued based on current share price of HK$54.70
• Our fair value estimate is 46% higher than Tsingtao Brewery's analyst price target of CN¥64.17

Today we will run through one way of estimating the intrinsic value of Tsingtao Brewery Company Limited (HKG:168) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 Tsingtao Brewery

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥4.46b	CN¥4.92b	CN¥4.84b	CN¥4.96b	CN¥5.08b	CN¥5.20b	CN¥5.32b	CN¥5.44b	CN¥5.56b	CN¥5.69b
Growth Rate Estimate Source	Analyst x7	Analyst x7	Analyst x1	Analyst x1	Est @ 2.35%	Est @ 2.32%	Est @ 2.30%	Est @ 2.29%	Est @ 2.27%	Est @ 2.27%
Present Value (CN¥, Millions) Discounted @ 6.2%	CN¥4.2k	CN¥4.4k	CN¥4.0k	CN¥3.9k	CN¥3.8k	CN¥3.6k	CN¥3.5k	CN¥3.4k	CN¥3.2k	CN¥3.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥37b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥5.7b× (1 + 2.3%) ÷ (6.2%– 2.3%) = CN¥146b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥146b÷ ( 1 + 6.2%)¹⁰= CN¥80b

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¥117b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$54.7, the company appears quite undervalued at a 41% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tsingtao Brewery 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 6.2%, 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 Tsingtao Brewery

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Tsingtao Brewery, we've compiled three pertinent items you should consider:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Tsingtao Brewery .
2. Future Earnings: How does 168'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. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock 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.