A look at the fair value of China Biotech Services Holdings Limited (HKG:8037)

Today we are going to give a simple overview of a valuation method used to estimate the attractiveness of China Biotech Services Holdings Limited (HKG:8037) as an investment opportunity by estimating the flow of the company’s future cash flows and discounting them to their present value. One way to do this is to use the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.

See our latest analysis for China Biotech Services Holdings

Step by step through the calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimates of free cash flow are available to us, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (HK$, Millions) HK$105.0 million HK$75.8 million HK$61.4 million HK$53.5 million HK$49.0 million HK$46.3 million HK$44.8 million HK$44.0 million HK$43.6 million HK$43.6 million
Growth rate estimate Source Is @ -40.43% Is @ -27.81% East @ -18.98% East @ -12.8% Is @ -8.48% East @ -5.45% Is @ -3.33% Is @ -1.84% Is @ -0.8% East @ -0.08%
Present value (HK$, millions) discounted at 6.3% HK$98.7 HK$67.0 HK$51.1 HK$41.9 HK$36.1 HK$32.1 HK$29.2 26.9HKD HK$25.1 HK$23.6

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = HK$431 million

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.3%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = HK$44 million × (1 + 1.6%) ÷ (6.3%–1.6%) = HK$942 million

Present value of terminal value (PVTV)= TV / (1 + r)ten= HK$942 million÷ (1 + 6.3%)ten= HK$510 million

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is HK$941 million. The final step is to divide the equity value by the number of shares outstanding. Against the current share price of HK$1.0, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.

SEHK: 8037 Discounted Cash Flow November 5, 2022

Important assumptions

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider China Biotech Services Holdings 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 takes debt into account. In this calculation, we used 6.3%, which is based on a leveraged beta of 0.805. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For China Biotech Services Holdings, we’ve rounded up three additional things you should evaluate:

  1. Financial health: 8037 does he have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
  2. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!
  3. Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!

PS. The Simply Wall St app performs an updated cash flow assessment for each SEHK stock every day. If you want to find the calculation for other stocks, search here.

Valuation is complex, but we help make it simple.

Find out if China Biotech Services Holdings is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

About Myra R.

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