Is TCL Electronics Holdings Limited (HKG:1070) Trading At A 45% Discount?

Key Insights

• TCL Electronics Holdings' estimated fair value is HK$21.91 based on 2 Stage Free Cash Flow to Equity
• TCL Electronics Holdings' HK$12.01 share price signals that it might be 45% undervalued
• Our fair value estimate is 55% higher than TCL Electronics Holdings' analyst price target of HK$14.09

Today we will run through one way of estimating the intrinsic value of TCL Electronics Holdings Limited (HKG:1070) by estimating the company's future cash flows and discounting them to their present value. This will be done using 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.

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The Model

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 begin with, we have to get estimates of 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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (HK$, Millions)	HK$3.02b	HK$3.29b	HK$3.50b	HK$3.68b	HK$3.84b	HK$4.00b	HK$4.14b	HK$4.29b	HK$4.42b	HK$4.56b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 6.28%	Est @ 5.24%	Est @ 4.51%	Est @ 4.01%	Est @ 3.65%	Est @ 3.40%	Est @ 3.23%	Est @ 3.10%
Present Value (HK$, Millions) Discounted @ 9.1%	HK$2.8k	HK$2.8k	HK$2.7k	HK$2.6k	HK$2.5k	HK$2.4k	HK$2.3k	HK$2.1k	HK$2.0k	HK$1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$24b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.8%) 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 9.1%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = HK$4.6b× (1 + 2.8%) ÷ (9.1%– 2.8%) = HK$75b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$75b÷ ( 1 + 9.1%)¹⁰= HK$31b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK$55b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$12.0, the company appears quite good value at a 45% 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.

The 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 TCL Electronics 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 9.1%, which is based on a levered beta of 1.232. 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.

Check out our latest analysis for TCL Electronics Holdings

SWOT Analysis for TCL Electronics Holdings

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. 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 TCL Electronics Holdings, we've compiled three relevant factors you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with TCL Electronics Holdings , and understanding it should be part of your investment process.
2. Future Earnings: How does 1070'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.