Estimating The Fair Value Of COSCO SHIPPING International (Hong Kong) Co., Ltd. (HKG:517)

Key Insights

• COSCO SHIPPING International (Hong Kong)’s estimated fair value is HK$3.06 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$3.26 suggests COSCO SHIPPING International (Hong Kong) is potentially trading close to its fair value
• COSCO SHIPPING International (Hong Kong)’s peers seem to be trading at a lower premium to fair value based onthe industry average of -2.4%

Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of COSCO SHIPPING International (Hong Kong) Co., Ltd. (HKG:517) as an investment opportunity by taking the expected future cash flows and discounting them to today’s 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.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for COSCO SHIPPING International (Hong Kong)

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. 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$290.7m	HK$287.8m	HK$287.4m	HK$288.7m	HK$291.3m	HK$294.7m	HK$298.8m	HK$303.4m	HK$308.4m	HK$313.7m
Growth Rate Estimate Source	Est @ -2.24%	Est @ -1.01%	Est @ -0.14%	Est @ 0.47%	Est @ 0.89%	Est @ 1.19%	Est @ 1.40%	Est @ 1.54%	Est @ 1.64%	Est @ 1.71%
Present Value (HK$, Millions) Discounted @ 7.9%	HK$269	HK$247	HK$229	HK$213	HK$199	HK$187	HK$176	HK$165	HK$156	HK$147

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$2.0b

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 1.9%. We discount the terminal cash flows to today’s value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$314m× (1 + 1.9%) ÷ (7.9%– 1.9%) = HK$5.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$5.3b÷ ( 1 + 7.9%)¹⁰= HK$2.5b

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$4.5b. 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$3.3, 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

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. 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 COSCO SHIPPING International (Hong Kong) 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 7.9%, which is based on a levered beta of 1.016. 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 COSCO SHIPPING International (Hong Kong)

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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 example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For COSCO SHIPPING International (Hong Kong), we’ve put together three essential factors you should look at:

1. Risks: Case in point, we’ve spotted 1 warning sign for COSCO SHIPPING International (Hong Kong) you should be aware of.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.