East Buy Holding Limited's (HKG:1797) Intrinsic Value Is Potentially 57% Above Its Share Price

Key Insights

• East Buy Holding's estimated fair value is HK$40.13 based on 2 Stage Free Cash Flow to Equity
• East Buy Holding's HK$25.60 share price signals that it might be 36% undervalued
• Analyst price target for 1797 is CN¥15.65 which is 61% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of East Buy Holding Limited (HKG:1797) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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What's The Estimated Valuation?

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, 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 (CN¥, Millions)	CN¥30.5m	CN¥269.7m	CN¥596.0m	CN¥889.6m	CN¥1.20b	CN¥1.51b	CN¥1.79b	CN¥2.04b	CN¥2.26b	CN¥2.44b
Growth Rate Estimate Source	Analyst x2	Analyst x3	Analyst x2	Est @ 49.26%	Est @ 35.29%	Est @ 25.51%	Est @ 18.66%	Est @ 13.87%	Est @ 10.52%	Est @ 8.17%
Present Value (CN¥, Millions) Discounted @ 6.9%	CN¥28.5	CN¥236	CN¥488	CN¥681	CN¥862	CN¥1.0k	CN¥1.1k	CN¥1.2k	CN¥1.2k	CN¥1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥8.1b

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 (2.7%) 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥2.4b× (1 + 2.7%) ÷ (6.9%– 2.7%) = CN¥60b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥60b÷ ( 1 + 6.9%)¹⁰= CN¥31b

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 CN¥39b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$25.6, the company appears quite good value at a 36% 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.

Important 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 East Buy Holding 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 6.9%, 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.

View our latest analysis for East Buy Holding

SWOT Analysis for East Buy Holding

Next Steps:

Although the valuation of a company is important, 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For East Buy Holding, there are three additional factors you should explore:

1. Risks: For example, we've discovered 3 warning signs for East Buy Holding that you should be aware of before investing here.
2. Future Earnings: How does 1797'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.

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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.