Is There An Opportunity With RISE Education Cayman Ltd's (NASDAQ:REDU) 40% Undervaluation?
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Does the July share price for RISE Education Cayman Ltd (NASDAQ:REDU) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
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.
View our latest analysis for RISE Education Cayman
Crunching the numbers
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. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
| 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | |
| Levered FCF (CN¥, Millions) | CN¥261.6m | CN¥283.9m | CN¥303.2m | CN¥320.1m | CN¥335.2m | CN¥349.0m | CN¥362.0m | CN¥374.3m | CN¥386.3m | CN¥398.2m |
| Growth Rate Estimate Source | Est @ 11.03% | Est @ 8.54% | Est @ 6.8% | Est @ 5.58% | Est @ 4.72% | Est @ 4.12% | Est @ 3.71% | Est @ 3.41% | Est @ 3.21% | Est @ 3.06% |
| Present Value (CN¥, Millions) Discounted @ 8% | CN¥242.2 | CN¥243.4 | CN¥240.7 | CN¥235.3 | CN¥228.2 | CN¥220.0 | CN¥211.3 | CN¥202.3 | CN¥193.3 | CN¥184.5 |
| ("Est" = FCF growth rate estimated by Simply Wall St) We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 8%. Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = CN¥398m × (1 + 2.7%) ÷ (8% – 2.7%) = CN¥7.8b Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = CN¥CN¥7.8b ÷ ( 1 + 8%)10 = CN¥3.60b 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¥5.80b. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate in the company's reported currency of CN¥102.16. However, REDU's primary listing is in China, and 1 share of REDU in CNY represents 0.145 ( CNY/ USD) share of NasdaqGM:REDU, so the intrinsic value per share in USD is $14.86. Compared to the current share price of $8.9, the company appears quite good value at a 40% 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. |