BOC Aviation Limited (HKG:2588) Shares Could Be 32% Below Their Intrinsic Value Estimate
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, BOC Aviation fair value estimate is HK$109
- BOC Aviation's HK$73.70 share price signals that it might be 32% undervalued
- Our fair value estimate is 28% higher than BOC Aviation's analyst price target of US$85.06
In this article we are going to estimate the intrinsic value of BOC Aviation Limited (HKG:2588) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
| 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2035 | |
| Levered FCF ($, Millions) | US$331.0m | US$362.4m | US$850.0m | US$913.6m | US$969.1m | US$1.02b | US$1.06b | US$1.11b | US$1.15b | US$1.18b |
| Growth Rate Estimate Source | Analyst x1 | Est @ 9.48% | Analyst x1 | Est @ 7.48% | Est @ 6.08% | Est @ 5.10% | Est @ 4.42% | Est @ 3.94% | Est @ 3.60% | Est @ 3.37% |
| Present Value ($, Millions) Discounted @ 11% | US$298 | US$293 | US$617 | US$597 | US$569 | US$538 | US$505 | US$471 | US$439 | US$408 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.7b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.
Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = US$1.2b× (1 + 2.8%) ÷ (11%– 2.8%) = US$14b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$14b÷ ( 1 + 11%)10= US$5.0b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$9.7b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$73.7, the company appears quite good value at a 32% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 BOC Aviation 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 11%, which is based on a levered beta of 2.000. 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.
Check out our latest analysis for BOC Aviation
SWOT Analysis for BOC Aviation
- No major strengths identified for 2588.
- Earnings declined over the past year.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Trade Distributors market.
- Annual revenue is forecast to grow faster than the Hong Kong market.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual earnings are forecast to grow slower than the Hong Kong market.
Next Steps:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For BOC Aviation, we've put together three important factors you should further research:
- Risks: Case in point, we've spotted 3 warning signs for BOC Aviation you should be aware of, and 1 of them is concerning.
- Future Earnings: How does 2588'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.
- 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!
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.