A Look At The Intrinsic Value Of Chervon Holdings Limited (HKG:2285)

Simply Wall St · 10/25 23:01

Key Insights

  • The projected fair value for Chervon Holdings is HK$18.47 based on 2 Stage Free Cash Flow to Equity
  • With HK$21.30 share price, Chervon Holdings appears to be trading close to its estimated fair value
  • Our fair value estimate is 35% lower than Chervon Holdings' analyst price target of US$28.24

How far off is Chervon Holdings Limited (HKG:2285) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Chervon Holdings

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. To start off with, we need to estimate 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.

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 ($, Millions) US$64.0m US$74.0m US$81.4m US$87.7m US$93.0m US$97.5m US$101.6m US$105.2m US$108.5m US$111.6m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 10.01% Est @ 7.68% Est @ 6.05% Est @ 4.91% Est @ 4.11% Est @ 3.55% Est @ 3.16% Est @ 2.89%
Present Value ($, Millions) Discounted @ 9.4% US$58.5 US$61.9 US$62.2 US$61.3 US$59.4 US$57.0 US$54.3 US$51.4 US$48.5 US$45.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$560m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$112m× (1 + 2.3%) ÷ (9.4%– 2.3%) = US$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.6b÷ ( 1 + 9.4%)10= US$655m

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 US$1.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$21.3, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
SEHK:2285 Discounted Cash Flow October 25th 2024

Important Assumptions

Now 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 Chervon 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 9.4%, which is based on a levered beta of 1.429. 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 Chervon Holdings

Strength
  • Cash in surplus of total debt.
Weakness
  • Expensive based on P/S ratio and estimated fair value.
Opportunity
  • Expected to breakeven next year.
  • Has sufficient cash runway for more than 3 years based on current free cash flows.
Threat
  • Debt is not well covered by operating cash flow.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Chervon Holdings, there are three additional elements you should assess:

  1. Financial Health: Does 2285 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 2285'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 SEHK every day. If you want to find the calculation for other stocks just search here.