Is There An Opportunity With WH Group Limited’s (HKG:288) 42.49% Undervaluation?

How far off is WH Group Limited (HKG:288) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for WH Group by following the link below. See our latest analysis for WH Group

Is 288 fairly valued?

I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

2018	2019	2020	2021	2022
Levered FCF ($, Millions)	$1.48k	$1.16k	$1.59k	$1.82k	$1.93k
Source	Analyst x2	Analyst x6	Analyst x6	Analyst x1	Analyst x1
Present Value Discounted @ 10.13%	$1.35k	$953.41	$1.19k	$1.24k	$1.19k

Present Value of 5-year Cash Flow (PVCF)= HK$5.91b

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 the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.1%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = HK$1.93b × (1 + 2.2%) ÷ (10.1% – 2.2%) = HK$24.90b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = HK$24.90b ÷ ( 1 + 10.1%)⁵ = HK$15.37b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is HK$21.28b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value in the company’s reported currency of $1.45. However, 288’s primary listing is in Hong Kong, and 1 share of 288 in USD represents 7.847 ( USD/ HKD) share of SEHK:288, so the intrinsic value per share in HKD is HK$11.39. Relative to the current share price of HK$6.55, the stock is quite good value at a 42.49% discount to what it is available for right now.

SEHK:288 Intrinsic Value June 23rd 18

Important assumptions

Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at WH Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.1%, which is based on a levered beta of 1.017. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 288, I’ve put together three fundamental aspects you should further research:

1. Financial Health: Does 288 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future Earnings: How does 288’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: Are there other high quality stocks you could be holding instead of 288? 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 for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.