Is There An Opportunity With PCCW Limited's (HKG:8) 24% Undervaluation?

Simply Wall St.

Sep 28

AdvertisementKey Insights Using the 2 Stage Free Cash Flow to Equity, PCCW fair value estimate is HK$6.83 PCCW's HK$5.20 share price signals that it might be 24% undervalued Industry average ...

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This will be done using the Discounted Cash Flow (DCF) model.  There's really not all that much to it, even though it might appear quite complex.  Remember though, that there are many ways to estimate a company's value, and a DCF is just one method.  If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model. 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 $10bn in marketcap - there is still time to get in early. The Method   We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate.  To start off with, we need to estimate the next ten years of cash flows.   Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.   A DCF is all about the idea that a dollar in the future is less valuable than a dollar today,  so we need to discount the sum of these future cash flows to arrive at a present value estimate:  10-year free cash flow (FCF) estimate  2026202720282029203020312032203320342035 Levered FCF (HK$, Millions) HK$3.15bHK$2.95bHK$2.84bHK$2.79bHK$2.78bHK$2.79bHK$2.82bHK$2.87bHK$2.93bHK$2.99bGrowth Rate Estimate SourceEst @ -10.34%Est @ -6.43%Est @ -3.69%Est @ -1.78%Est @ -0.44%Est @ 0.50%Est @ 1.16%Est @ 1.62%Est @ 1.94%Est @ 2.16% Present Value (HK$, Millions) Discounted @ 7.3% HK$2.9kHK$2.6kHK$2.3kHK$2.1kHK$2.0kHK$1.8kHK$1.7kHK$1.6kHK$1.6kHK$1.5k(\"Est\" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = HK$20b After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage.  For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.7%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.3%. Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = HK$3.0b× (1 + 2.7%) ÷ (7.3%– 2.7%) = HK$66bPresent Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$66b÷ ( 1 + 7.3%)10= HK$33b 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$53b.  In the final step we divide the equity value by the number of shares outstanding.  Relative to the current share price of HK$5.2, the company appears   a touch undervalued    at a 24% 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. SEHK:8 Discounted Cash Flow September 28th 2025  Important Assumptions  Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.  Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 PCCW 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 7.3%, which is based on a levered beta of 0.906. 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 PCCW SWOT Analysis for PCCWStrength Dividend is in the top 25% of dividend payers in the market.  Dividend information for 8. WeaknessInterest payments on debt are not well covered.Opportunity Expected to breakeven next year. Has sufficient cash runway for more than 3 years based on current free cash flows. Trading below our estimate of fair value by more than 20%. ThreatDebt is not well covered by operating cash flow. Paying a dividend but company is unprofitable. Is 8 well equipped to handle threats?  Looking Ahead:  Whilst important, the DCF calculation  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.  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.   Can we work out why the company is trading at a discount to intrinsic value?   For PCCW, there are three  additional  factors  you should assess:   Risks: Take risks, for example - PCCW has   2 warning signs  (and 1 which is significant)  we think you should know about.  Future Earnings: How does 8'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.New: Manage All Your Stock Portfolios in One PlaceWe've created the ultimate portfolio companion for stock investors, and it's free.• Connect an unlimited number of Portfolios and see your total in one currency• Be alerted to new Warning Signs or Risks via email or mobile• Track the Fair Value of your stocksTry a Demo Portfolio for FreeHave 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"}}}