An Intrinsic Calculation For China MeiDong Auto Holdings Limited (HKG:1268) Suggests It's 30% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China MeiDong Auto Holdings fair value estimate is HK$1.94
• China MeiDong Auto Holdings is estimated to be 30% undervalued based on current share price of HK$1.36
• Analyst price target for 1268 is CN¥2.29, which is 19% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of China MeiDong Auto Holdings Limited (HKG:1268) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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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Is China MeiDong Auto Holdings Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 (CN¥, Millions)	CN¥307.3m	CN¥280.7m	CN¥266.1m	CN¥258.6m	CN¥255.7m	CN¥255.9m	CN¥258.1m	CN¥261.9m	CN¥266.8m	CN¥272.6m
Growth Rate Estimate Source	Est @ -13.59%	Est @ -8.66%	Est @ -5.22%	Est @ -2.81%	Est @ -1.12%	Est @ 0.06%	Est @ 0.89%	Est @ 1.47%	Est @ 1.87%	Est @ 2.16%
Present Value (CN¥, Millions) Discounted @ 13%	CN¥272	CN¥221	CN¥185	CN¥160	CN¥140	CN¥124	CN¥111	CN¥100	CN¥90.4	CN¥81.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.5b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥273m× (1 + 2.8%) ÷ (13%– 2.8%) = CN¥2.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥2.8b÷ ( 1 + 13%)¹⁰= CN¥844m

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¥2.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$1.4, the company appears a touch undervalued at a 30% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 China MeiDong Auto 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 13%, which is based on a levered beta of 1.898. 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 China MeiDong Auto Holdings

SWOT Analysis for China MeiDong Auto Holdings

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For China MeiDong Auto Holdings, we've compiled three relevant elements you should further research:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with China MeiDong Auto Holdings .
2. Future Earnings: How does 1268'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.