Melco International Development Limited (HKG:200) Is Trading At A 47.56% Discount

In this article I am going to calculate the intrinsic value of Melco International Development Limited (HKG:200) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Melco International Development by following the link below. Check out our latest analysis for Melco International Development

The model

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. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow forecast

2018	2019	2020	2021	2022
Levered FCF (HK$, Millions)	HK$5.14k	HK$10.25k	HK$10.92k	HK$12.78k	HK$14.82k
Source	Analyst x1	Analyst x2	Analyst x1	Extrapolated @ (17%, capped from 85.74%)	Extrapolated @ (16%, capped from 85.74%)
Present Value Discounted @ 17.8%	HK$4.36k	HK$7.39k	HK$6.68k	HK$6.64k	HK$6.53k

Present Value of 5-year Cash Flow (PVCF)= HK$31.60b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 17.8%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = HK$14.82b × (1 + 2.2%) ÷ (17.8% – 2.2%) = HK$97.14b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = HK$97.14b ÷ ( 1 + 17.8%)⁵ = HK$42.83b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is HK$74.43b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of HK$48.91. Compared to the current share price of HK$25.65, the stock is quite good value at a 47.56% discount to what it is available for right now.

SEHK:200 Intrinsic Value June 24th 18

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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Melco International Development as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 17.8%, which is based on a levered beta of 2. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 200, I’ve compiled three essential factors you should look at:

1. Financial Health: Does 200 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future Earnings: How does 200’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.

3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 200? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St does a DCF calculation for every HK stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.