Below are the data sources, inputs and calculation used to determine the intrinsic value for Hong Leong Industries Berhad.
KLSE:HLIND Discounted Cash Flow Data Sources Data Point Source Value Valuation Model 2 Stage Free Cash Flow to Equity Levered Free Cash Flow Average of 1 Analyst Estimates (S&P Global) See below Discount Rate (Cost of Equity) See below 9.8% Perpetual Growth Rate 10-Year MY Government Bond Rate 3.4% An important part of a discounted cash flow is the discount rate, below we explain how it has been calculated.
Calculation of Discount Rate/ Cost of Equity for KLSE:HLIND Data Point Calculation/ Source Result Risk-Free Rate 10-Year MY Govt Bond Rate 3.4% Equity Risk Premium S&P Global 7.0% Industrials Unlevered Beta Simply Wall St/ S&P Global 0.87 Re-levered Beta = 0.33 + [(0.66 * Unlevered beta) * (1 + (1 - tax rate) (Debt/Market Equity))] = 0.33 + [(0.66 * 0.868) * (1 + (1 - 24.0%) (1.96%))] 0.920 Levered Beta Levered Beta limited to 0.8 to 2.0 (practical range for a stable firm) 0.920 Discount Rate/ Cost of Equity = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium) = 3.42% + (0.920 * 6.96%) 9.83% Discounted Cash Flow Calculation for KLSE:HLIND using 2 Stage Free Cash Flow to Equity Model
The calculations below outline how an intrinsic value for Hong Leong Industries Berhad is arrived at by discounting future cash flows to their present value using the 2 stage method. We use analyst's estimates of cash flows going forward 5 years for the 1st stage, the 2nd stage assumes the company grows at a stable rate into perpetuity.
KLSE:HLIND DCF 1st Stage: Next 5 year cash flow forecast Levered FCF (MYR, Millions) Source Present Value Discounted (@ 9.83%) 2020 515.72 Est @ 2.93% 469.58 2021 531.59 Est @ 3.08% 440.73 2022 548.5 Est @ 3.18% 414.07 2023 566.34 Est @ 3.25% 389.28 2024 585.04 Est @ 3.3% 366.16 2025 604.57 Est @ 3.34% 344.54 2026 624.9 Est @ 3.36% 324.26 2027 646.02 Est @ 3.38% 305.23 2028 667.93 Est @ 3.39% 287.35 2029 690.65 Est @ 3.4% 270.54 Present value of next 5 years cash flows MYR3,611 KLSE:HLIND DCF 2nd Stage: Terminal Value Calculation Result Terminal Value FCF2029 × (1 + g) ÷ (Discount Rate – g) = MYR690.645 x (1 + 3.42%) ÷ (9.83% - 3.42% ) MYR11,151.18 Present Value of Terminal Value = Terminal Value ÷ (1 + r)10 MYR11,151 ÷ (1 + 9.83%)10 MYR4,368.15 KLSE:HLIND Total Equity Value Calculation Result Total Equity Value = Present value of next 10 years cash flows + Terminal Value = MYR3,611 + MYR4,368 MYR7,979.15 Equity Value per Share (MYR) = Total value / Shares Outstanding = MYR7,979 / 314 MYR25.41 KLSE:HLIND Discount to Share Price Calculation Result Value per share (MYR) From above.
Wow. Your analysis is so complicating that most people may not understand. Although I have been a serious investor for over 45 years and had been a successful one, I never resort to such meticulous and complicating calculation. I wonder if fund managers and stock analyst use such detailed method before they make recommendations for lay investors to buy. Anyway, good job and thanks for effort.
"We use analyst's estimates of cash flows going forward 5 years for the 1st stage, the 2nd stage assumes the company grows at a stable rate into perpetuity."
@Gemstar, thanks for your sharing. I also use discounted cash flow model for the purpose of double checking. I’ll vary the assumed initial FCF, growth rate, perpetual growth, discount rate to get an idea of different fair values under different assumptions. I also reverse calculate from the current price to understand what are the assumptions implied in the current share price.
After doing one company, the exercise can be extended to other companies (although very time consuming). While I don’t believe in a precise fair value (that doesn’t exist), I think such exercise helps to understand relative attractiveness across different companies.
But back to your valuation, I have a few questions/ comments:
1. Your stage 1 is based on 10-year period, not 5 years as mentioned
2. Your discount rate of 9.8% seems fair. I’m wary of using beta to calculate discount rate, as beta changes over time when share price swings. But I think a 10% discount for a conservative company with a huge net cash position is fair.
3. I’m skeptical about the year 2020 FCF projected by the analyst you mentioned (BTW which analyst?). I guess the projection RM515.72 million is related to the trailing 12 months FCF which is RM512 million. But during the MCO of at least 8 weeks, sales & factory operation across all businesses will be severely impacted. There is also potentially weak demand post-MCO. Vietnam associate may face similar challenges. The company may bounce back in 2021, but I think 2020 will see a much lower FCF than the past 12 months.
4. Your FCF growth rate assumption starts at 2.93% in the first year, and it grows faster and faster until 3.4%, and the perpetual growth rate is the highest at 3.42%. Such an assumption is unusual because all businesses face increasing competition over time. A prudent approach might be to start with a higher growth rate, but settle with a lower perpetual growth rate at the terminal stage.
Try varying those assumptions and the fair value can differ substantially.
@Gemstar, thanks for the good effort. Getting different views and feedback will allow us to learn together. But I have some reservation on the assumptions and generally agree with Observatory's comments on initial FCF and FCF growth assumption (looking at past years average FCF, 500 mil is definitely on the very high side). For me, 300 to 400 mil would be a more reasonable range.
What contribute to the growth assumption? If it is motorcycle sales, which is a durable consumer goods, what drive it? Population growth or inflation? Dont think can derive growth from building materials unit.
There is one area you may want to rethink again in your IV calculation...Has the Non Controlling Interest (or Minority Interest as I, the old timer used to know it in the past) been factored in? If we look at the Income statement and Balance sheet, this NCI is rather substantial.
Anyway, IV is a just an indicator as there are too many variables and assumptions in the model. BUt one thing is sure, it has lots of cash and is a strong cash generator with minimum CAPEX.
understandably, as majority of businesses are affected by the mco /cmco due to coronavirus.. hope there won't be a 2nd wave of infections after raya and business can stabilize and prosper once again
The only reits i bought is Alaqar.i expect it to affected by the pandemic. But long term wise the earnings quite stable. Avoid retail and office reits. Online shopping and work from home will kill these reits.
I personally has gained from this counter but if you look at the businesses, apart from Yamaha, need to be aware of its other businesses. Looks like in trouble.
HLIND release latest quarterly report yesterday, my analysis:
Prelog: many people thought that HLIND involved deeply in construction industry, but the fact is HLIND generates most of its revenue and profit from selling Yamaha branded motorbikes from its majority owned subsidiary of Hong Leong Yamaha Motor.
Reporting Quarter performance
1) The reporting quarter (FY2020Q4, quarter ended 30 June 2020) is a non-comparable, non-repeatable quarter for most businesses in Malaysia, especially for local consumer market (e.g. motorbikes market for HLIND).
2) However, HLIND managed to deliver positive gross profit (though only 15% GP margin compared to 19% in normal quarter) at reported revenue which was less than half of normal period (imagine your factory closed & your customers closed shop, but you still need to continue depreciation, pay basic salary to workers, keep machines warm etc.)
3) Net loss after tax for the quarter = RM25.5 million for the quarter. Remember this is Q4 result, with some year-end accounting impacts: loss of RM11.1 million from discontinued operation (will not repeat in future) and damage of RM11.8 million due to impairment of assets (likely will not repeat in future, with probability of reversal). To take out the 2 factors, net loss after tax will reduce to RM2.6 million and it will turn loss before tax to small profit before tax (which is an incredible performance for MCO period for a mainly local consumer market based company).
FY2020 performance and prospect:
4) At least 2 months loss of motorbikes sales (biggest revenue and profit contributor), mostly happened in last quarter. Assuming sales in first half (July – Sept 2019) are normal and average, the whole FY2020 sales lost averagely 2.3 months of revenue due to MCO.
5) Despite lower sales, HLIND still delivered RM169.4 million of profit after tax attributable to shareholders, i.e. RM0.54 per share.
6) MCO kind of lockdown is an UNLIKELY event to repeat in FY2021. Revenge sales pick-up will happen in at least next reporting quarter (due to MCO loss of sales in previous 2 reported quarters), i.e. FY2021 sales will be higher compared to FY2020, and expectedly better profit.
7) History trend: Bad economy (before Vaccine for COVID-19, a likely event) is beneficiary to motorbikes sales (people tend to buy motorbikes instead of cars when economy is not good).
8) HLIND's bad business portfolio like Hume Roofing has been discontinued. This will contribute positively to HLIND's overall result in FY2021 (info: the discontinued operation had burdened HLIND with RM10 million of loss or 3 sen per share in FY2020 alone (or 90 sen potential price upward if valued at 20x P/E for this discontinuation of operation event alone).
Others:
9) Solid overall Balance Sheet: - Cash & bank balances stood at RM1.2 billion, with negligible borrowings. - Current ratio: 5.21 (> 1.5 consider particularly healthy) - Quick ratio: 4.55 (> 1 consider particularly healthy) - Gearing: N/M (net cash company, gearing is not meaningful)
10) Strong cash flow: - Operating cash flow of RM423 million (> net profit) (RM1.35 per share) - Free cash flow of RM375 million (> net profit) (RM1.19 per share)
11) Other Financial Indicators (assuming share price of RM7.70): Net cash per share = RM3.80 (49.45% of share price) Equity per share = RM5.34 (69.35% of share price) P/E (FY2020) = 14.3x (< 25x (4% ROI) considered good buy, given HLIND’s strong balance sheet health) EV/EBITDA (FY2020) = 3.0x (< 10x considered good buy) Dividend Yield = 5.5% (> your FD interest rate, now < 2%, considered good already) Z Score = 7.27 (testing health for bankruptcy, > 3 considered healthy)
Conclusion:
Good health (extremely good Z Score, no risk of bankruptcy), good prospect (motorbikes are still selling well in Malaysia, especially when economy is down), good product (Yamaha is the best-selling motorbike brand in Malaysia), good P/E, good EV/EBITDA, good dividend (even based on performance badly hit by MCO and COVID-19). What else to expect?
Target price: RM12.00
Even for RM12 future target price to apply to FY2020 one-time MCO affected performance, you still get: - P/E = 22.2x (4.5% ROI) - EV/EBITDA = 6.4x - Dividend Yield = 3.5% Still an ATTRACTIVE investment, isn’t it? (Don’t forget, it is highly likely that FY2021 will be a lot better than FY2020)
Writer’s interest: 2,500 HLIND shares held at RM7.68 average cost.
Regard the writer: I wrote above mainly for other purpose. I visited i3investor as guest on and off and never commented anything. This is my first comment of any kind, just sharing my writing and not to waste it.
tclittley, thanks for the indepth analysis on HLIND. I have been having waiving heart to sell of my holdings but your analysis gave me confident to continue to hold for long-term.
tclittley your kind of analysis is why it is still valuable to drop by 3i. Thanks a lot. Good QR given the situation, agree with you. And yes. fair value of this company should actually be rounding RM 12.
Back to fair value computation based on future perpetual discounted Free Cash Flow (FCF) model adopted by Gemstar back on 17 April.
(Warning: technical dry stuff ahead)
I change some assumptions to be more conservative and some to actual value (still perpetual): Free cash flow = RM366m (FY2020 actual FCF, also deduct investment in intangible asset) Growth Rate = 0% Discount Rate = 9.83% (per Gemstar’s working)
Since there is no assumption of change of growth rate, the terminal value as at end of FY2020 will equal sum of future perpetual discounted FCF.
Terminal Value as at end of FY2020 = RM366m X (1 + 0%) / (9.83% - 0%) = RM3,723m
Fair Entity Value = Terminal Value as at end of FY2020 = RM3,723m
Fair Value per share = RM3,723m / 314m shares = RM11.86
Judge yourself if you are agreeable to the assumptions made, especially: - RM366m of FY2020 FCF, fair? - at low side due to MCO? or - at high side due to lower sales (so changes on working capital at the positive side)? or - FY2019 FCF = RM402m - 0% growth rate, fair? - Ignore inflation rate? - Ignore population growth rate? - Ignore urbanization growth rate (and motorbikes usage will go down)? - Perpetual (i.e. HLIND will live forever), fair? - still somehow acceptable for 0% growth rate assumption - well, if HLIND could continue this operation level for long enough, say another 30 years, there is almost no difference to perpetual for this purpose (30 years = 98.5% of perpetual, 20 years = 88.7% of perpetual, 10 years = 63.8% of perpetual, with 0% growth rate and 9.83% discount rate).
Side note: Assuming 3% growth rate to somehow reflect inflation rate compounded with population growth rates, the fair values above will increase by a whopping 48%.
Another side note: assuming FCF per year = RM402m (FY2019 actual), and all other assumption no change (including 0% growth rate), this gives fair value per share = RM13.02.
Yet another side note: Perpetual discounted future FCF assumption means assuming no converting of fixed assets and other current assets (minus liabilities) into cash at the end of business (because no end of business). But cash is cash, in fact, current cash and bank balances (minus borrowings to be fair) should be added on to the terminal value (also the discounted future FCF), which will add another RM3.80 to the fair values per share computed above.
So, fair values = RM15.66 per share (RM366m FCF assumption), or RM16.82 per share (RM402m FCF assumption) (both with 0% growth rate, 9.83% discount rate and perpetual assumptions)
Above are just products of mathematics, judge yourself for your own investment.
Sorry, same mistake made, forgot to account for non-controlling interest (minority interest).
While, without full information, there is no way to segregate the cash flow and cash & bank balance between HLIND's shareholders and minority shareholders of subsidiaries.
To make thing simplified a bit, just assume all the cash flows and cash & bank balances are 100% from Hong Leong Yamaha Motor, then discount all fair values above by 30.4% will do.
This book is the result of the author's many years of experience and observation throughout his 26 years in the stockbroking industry. It was written for general public to learn to invest based on facts and not on fantasies or hearsay....
kingJ
129 posts
Posted by kingJ > 2020-04-09 19:19 | Report Abuse
With the over 1b in bank, now its time to invest in good potential companies