Home Discount rate Swire Properties Limited Embedded Value Estimate (HKG: 1972)

Swire Properties Limited Embedded Value Estimate (HKG: 1972)

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How far is Swire Properties Limited (HKG: 1972) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking the company’s future cash flow forecast and discounting it 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!

We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. Anyone interested in knowing a little more about intrinsic value should read the Simply Wall St analysis model.

Check out our latest review for Swire properties

The calculation

We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. 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.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (HK $, Million) HK $ 4.52 billion HK $ 6.19 billion HK $ 6.92 billion HK $ 8.14 billion HK $ 9.03 billion HK $ 9.77 billion HK $ 10.4 billion HK $ 10.9 billion HK $ 11.3 billion HK $ 11.6 billion
Source of estimated growth rate Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ 10.94% Est @ 8.1% Est @ 6.11% East @ 4.72% East @ 3.75% East @ 3.07%
Present value (HK $, Millions) discounted at 7.7% HK $ 4.2k HK $ 5.3k 5.5,000 HK $ HK $ 6.1k HK $ 6.2k 6.3k HK $ HK $ 6.2k HK $ 6.0k 5.8,000 HK $ 5.5,000 HK $

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = HK $ 57 billion

It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. 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 used the 5-year average of the 10-year government bond yield (1.5%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.7%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK $ 12 billion × (1 + 1.5%) ÷ (7.7% – 1.5%) = HK $ 189 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= HK $ 189 billion ÷ (1 + 7.7%)ten= HK $ 90 billion

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is HK $ 147 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 22.4, the company appears to be roughly at fair value with an 11% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.

SEHK: 1972 Discounted cash flow July 12, 2021

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. If you don’t agree with these results, try the calculation yourself and play with the 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 complete picture of a company’s potential performance. Since we view Swire Properties 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 debt. In this calculation, we used 7.7%, which is based on a leveraged beta of 1.171. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.

Next steps:

While a business valuation is important, ideally it won’t be the only analysis you review for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Swire properties, there are three essential aspects that you should consider further:

  1. Risks: Take risks, for example – Swire Properties has 3 warning signs we think you should be aware.
  2. Future benefits: How does the 1972 growth rate compare with that of its peers and the broader market? Dig deeper into the analyst consensus count 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 might not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, just search here.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares 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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