An Intrinsic Calculation For Guangzhou Restaurant Group Company Limited (SHSE:603043) Suggests It's 29% Undervalued

Simply Wall St · 10/18 01:04

Key Insights

Today we will run through one way of estimating the intrinsic value of Guangzhou Restaurant Group Company Limited (SHSE:603043) by taking the expected future cash flows and discounting them 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Guangzhou Restaurant Group

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (CN¥, Millions) CN¥863.0m CN¥819.0m CN¥798.4m CN¥791.2m CN¥792.9m CN¥800.9m CN¥813.4m CN¥829.3m CN¥847.7m CN¥868.1m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -2.52% Est @ -0.91% Est @ 0.22% Est @ 1.01% Est @ 1.56% Est @ 1.95% Est @ 2.22% Est @ 2.41%
Present Value (CN¥, Millions) Discounted @ 8.8% CN¥793 CN¥692 CN¥620 CN¥565 CN¥521 CN¥484 CN¥452 CN¥423 CN¥398 CN¥374

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.3b

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. 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 (2.9%) 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 8.8%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = CN¥868m× (1 + 2.9%) ÷ (8.8%– 2.9%) = CN¥15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥15b÷ ( 1 + 8.8%)10= CN¥6.5b

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¥12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥14.8, the company appears a touch undervalued at a 29% 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.

dcf
SHSE:603043 Discounted Cash Flow October 18th 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. 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 Guangzhou Restaurant 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 8.8%, which is based on a levered beta of 1.189. 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 Guangzhou Restaurant Group

Strength
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Earnings declined over 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 Chinese market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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 Guangzhou Restaurant Group, we've put together three important aspects you should explore:

  1. Risks: You should be aware of the 1 warning sign for Guangzhou Restaurant Group we've uncovered before considering an investment in the company.
  2. Future Earnings: How does 603043'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. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.