Calculating The Intrinsic Value Of Kafelaku Coffee Holding Limited (HKG:1869)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Kafelaku Coffee Holding fair value estimate is HK$0.10
• With HK$0.11 share price, Kafelaku Coffee Holding appears to be trading close to its estimated fair value
• Kafelaku Coffee Holding's peers seem to be trading at a higher premium to fair value based onthe industry average of -29%

How far off is Kafelaku Coffee Holding Limited (HKG:1869) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (HK$, Millions)	HK$10.2m	HK$10.1m	HK$10.1m	HK$10.2m	HK$10.3m	HK$10.5m	HK$10.7m	HK$11.0m	HK$11.2m	HK$11.5m
Growth Rate Estimate Source	Est @ -2.96%	Est @ -1.23%	Est @ -0.01%	Est @ 0.84%	Est @ 1.43%	Est @ 1.85%	Est @ 2.14%	Est @ 2.34%	Est @ 2.49%	Est @ 2.59%
Present Value (HK$, Millions) Discounted @ 9.2%	HK$9.3	HK$8.5	HK$7.7	HK$7.1	HK$6.6	HK$6.2	HK$5.8	HK$5.4	HK$5.1	HK$4.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$67m

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = HK$12m× (1 + 2.8%) ÷ (9.2%– 2.8%) = HK$186m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$186m÷ ( 1 + 9.2%)¹⁰= HK$77m

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$144m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.1, 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Kafelaku Coffee 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 9.2%, which is based on a levered beta of 1.251. 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.

See our latest analysis for Kafelaku Coffee Holding

SWOT Analysis for Kafelaku Coffee Holding

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Kafelaku Coffee Holding, we've put together three essential elements you should further examine:

1. Risks: For example, we've discovered 3 warning signs for Kafelaku Coffee Holding (2 are potentially serious!) that you should be aware of before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1869's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.