A Look At The Intrinsic Value Of Neo-Neon Holdings Limited (HKG:1868)
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Neo-Neon Holdings fair value estimate is HK$0.29
- With HK$0.35 share price, Neo-Neon Holdings appears to be trading close to its estimated fair value
- Industry average of 155% suggests Neo-Neon Holdings' peers are currently trading at a higher premium to fair value
Does the December share price for Neo-Neon Holdings Limited (HKG:1868) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Step By Step Through The Calculation
We're 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 a stable growth rate. 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) estimate
| 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2035 | |
| Levered FCF (CN¥, Millions) | CN¥55.9m | CN¥48.5m | CN¥44.4m | CN¥42.2m | CN¥41.1m | CN¥40.7m | CN¥40.7m | CN¥41.1m | CN¥41.7m | CN¥42.5m |
| Growth Rate Estimate Source | Est @ -20.02% | Est @ -13.17% | Est @ -8.37% | Est @ -5.01% | Est @ -2.66% | Est @ -1.02% | Est @ 0.13% | Est @ 0.94% | Est @ 1.50% | Est @ 1.90% |
| Present Value (CN¥, Millions) Discounted @ 9.4% | CN¥51.1 | CN¥40.5 | CN¥34.0 | CN¥29.5 | CN¥26.3 | CN¥23.8 | CN¥21.8 | CN¥20.1 | CN¥18.6 | CN¥17.4 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥283m
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 (2.8%) 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 9.4%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = CN¥43m× (1 + 2.8%) ÷ (9.4%– 2.8%) = CN¥667m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥667m÷ ( 1 + 9.4%)10= CN¥272m
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¥555m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.3, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
Now 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 Neo-Neon 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 9.4%, which is based on a levered beta of 1.285. 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.
View our latest analysis for Neo-Neon Holdings
Looking Ahead:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 Neo-Neon Holdings, we've put together three important elements you should further examine:
- Risks: For example, we've discovered 2 warning signs for Neo-Neon Holdings that you should be aware of before investing here.
- 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!
- 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.