Key Insights

• Using the 2 Stage Free Cash Flow to Equity, China East Education Holdings fair value estimate is HK$2.75

• China East Education Holdings' HK$2.38 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for 667 is CN¥4.30, which is 56% above our fair value estimate

Does the April share price for China East Education Holdings Limited (HKG:667) reflect what it's really worth? Today, we will estimate the stock's intrinsic value  by taking the expected future cash flows and discounting them to their present value.  One way to achieve this is by employing the Discounted Cash Flow (DCF) model.  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.  For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Crunching The Numbers

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.   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.  

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

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.1b

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 (2.0%) 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 7.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥381m× (1 + 2.0%) ÷ (7.5%– 2.0%) = CN¥7.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥7.1b÷ ( 1 + 7.5%)10= CN¥3.4b

The total value, or equity value, is then the sum of the present value of the future cash flows,  which in this case is CN¥5.5b.  In the final step we divide the equity value by the number of shares outstanding.  Compared to the current share price of HK$2.4, the company appears   about fair value    at a 13% 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.

SEHK:667 Discounted Cash Flow April 29th 2024

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 China East Education 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 7.5%, which is based on a levered beta of 0.973. 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 China East Education Holdings

Strength

• Currently debt free.

• Dividend is in the top 25% of dividend payers in the market.

• Dividend information for 667.

Weakness

• Earnings declined over the past year.

Opportunity

• Annual earnings are forecast to grow faster than the Hong Kong market.

• Current share price is below our estimate of fair value.

Threat

• Dividends are not covered by earnings and cashflows.

• Revenue is forecast to grow slower than 20% per year.

• See 667's dividend history.

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.  For China East Education Holdings, we've put together three  additional  factors  you should further examine:

1. Risks: We feel that you should assess the 1 warning sign for China East Education Holdings we've flagged before making an investment in the company.

2. Future Earnings: How does 667'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.

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.