An Intrinsic Calculation For The Hong Kong and China Gas Company Limited (HKG:3) Suggests It's 25% Undervalued

Simply Wall St.

10/11

AdvertisementKey Insights Hong Kong and China Gas' estimated fair value is HK$9.34 based on 2 Stage Free Cash Flow to Equity Hong Kong and China Gas is estimated to be 25% undervalued based on ...

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This will be done using the Discounted Cash Flow (DCF) model.  Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.  We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios.  For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you. AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early. The Calculation   We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase.  To begin with, we have to get estimates of the next ten years of cash flows.   Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.   Generally we assume that a dollar today is more valuable than a dollar in the future,  and so the sum of these future cash flows is then discounted to today's value:  10-year free cash flow (FCF) forecast  2026202720282029203020312032203320342035 Levered FCF (HK$, Millions) HK$6.20bHK$6.72bHK$7.12bHK$7.47bHK$7.79bHK$8.09bHK$8.37bHK$8.64bHK$8.90bHK$9.17bGrowth Rate Estimate SourceAnalyst x2Analyst x2Est @ 5.95%Est @ 4.97%Est @ 4.29%Est @ 3.81%Est @ 3.47%Est @ 3.24%Est @ 3.07%Est @ 2.96% Present Value (HK$, Millions) Discounted @ 6.8% HK$5.8kHK$5.9kHK$5.8kHK$5.7kHK$5.6kHK$5.5kHK$5.3kHK$5.1kHK$4.9kHK$4.8k(\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$54b 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 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%. Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = HK$9.2b× (1 + 2.7%) ÷ (6.8%– 2.7%) = HK$231bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$231b÷ ( 1 + 6.8%)10= HK$120b The total value, or equity value, is then the sum of the present value of the future cash flows,  which in this case is HK$174b.  To get the intrinsic value per share, we divide this by the total number of shares outstanding.  Compared to the current share price of HK$7.0, the company appears   a touch undervalued    at a 25% discount to where the stock price trades currently.   Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. SEHK:3 Discounted Cash Flow October 10th 2025  The Assumptions  The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows.  If you don't agree with these result, have a go at the calculation yourself and play with the 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 Hong Kong and China Gas 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 6.8%, which is based on a levered beta of 0.800. 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 Hong Kong and China Gas SWOT Analysis for Hong Kong and China GasStrength Earnings growth over the past year exceeded the industry. Debt is well covered by earnings. Balance sheet summary for 3. Weakness Dividend is low compared to the top 25% of dividend payers in the Gas Utilities market.Opportunity Annual earnings are forecast to grow for the next 3 years. Trading below our estimate of fair value by more than 20%. ThreatDebt is not well covered by operating cash flow. Dividends are not covered by earnings and cashflows.  Annual earnings are forecast to grow slower than the Hong Kong market. Is 3 well equipped to handle threats?  Moving On:  Although the valuation of a company is important, it  shouldn't be the only metric you look at when researching a company.  DCF models are not the be-all and end-all of investment valuation.  Rather it should be seen as a guide to \"what assumptions need to be true for this stock to be under/overvalued?\"  For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation.   What is the reason for the share price sitting below the intrinsic value?   For Hong Kong and China Gas, there are three  important  factors  you should look at:   Risks: You should be aware of the 2 warning signs for Hong Kong and China Gas we've uncovered before considering an investment in the company.  Future Earnings: How does 3'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. 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.Valuation is complex, but we're here to simplify it.Discover if Hong Kong and China Gas might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.Access Free AnalysisHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0,"need_auth":false,"code":"91000000","status":"200"}}}