Modern Earth Intrinsic Value Calculation (China) Co., Limited (HKG: 1107)


Does Modern Land (China) Co., Limited (HKG: 1107) share price in January reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it’s not too hard to follow, as you will see in our example!

Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Modern Land (China)

The calculation

We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth, and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of those future cash flows to their estimated value in today’s dollars:

10-year Free Cash Flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (CN ¥, Million) CN ¥ 154.9m CN ¥ 101.9m CN ¥ 78.0m CN ¥ 65.5m CN ¥ 58.4m CN ¥ 54.3m CN ¥ 51.9m CN ¥ 50.4m CN ¥ 49.7m CN ¥ 49.4m
Source of estimated growth rate Is @ -49.5% Is @ -34.21% Is @ -23.5% Is @ -16.01% Is @ -10.76% Is @ -7.09% Is @ -4.52% East @ -2.72% Is @ -1.46% East @ -0.58%
Present value (CN ¥, million) discounted at 11% CN ¥ 139 CN ¥ 82.1 CN ¥ 56.4 CN ¥ 42.5 CN ¥ 34.0 CN ¥ 28.4 CN ¥ 24.3 CN ¥ 21.2 CN ¥ 18.8 CN ¥ 16.8

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = CN ¥ 463m

After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 11%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN ¥ 49m × (1 + 1.5%) ÷ (11% – 1.5%) = CN ¥ 505m

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN ¥ 505m ÷ (1 + 11%)ten= CN ¥ 171m

The total value, or net worth, is then the sum of the present value of the future cash flows, which in this case is CN 634 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK $ 0.2, the company appears to be roughly at fair value with an 18% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.

SEHK: 1107 Discounted cash flow January 10, 2022

The hypotheses

We draw your attention to the fact 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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider Modern Land (China) 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 takes into account the debt. In this calculation, we used 11%, which is based on a leveraged beta of 2,000. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a business. The DCF model is not a perfect stock assessment tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Modern Land (China), we have compiled three important aspects that you should explore further:

  1. Risks: To this end, you should inquire about the 3 warning signs we spotted with Modern Land (China) (including 2 which do not suit us too much).
  2. Future benefits: How does 1107’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
  3. Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!

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.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.


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