Today we will walk through a way to estimate the intrinsic value of Shenzhen Neptunus Interlong Bio-technique Company Limited (HKG:8329) by taking expected future cash flows and discounting them to present value. We will use the Discounted Cash Flow (DCF) model for this purpose. There really isn’t much to do, although it may seem quite complex.
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. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest analysis for Shenzhen Neptunus Interlong Bio-technique
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (CN¥, Million)||CN¥20.5m||CN¥14.7m||11.8 million Canadian yen||CN¥10.3m||CN¥9.39m||CN¥8.86m||CN¥8.55m||CN¥8.38m||CN¥8.30m||CN¥8.29m|
|Growth rate estimate Source||Is @ -41.2%||East @ -28.38%||East @ -19.4%||Is @ -13.11%||Is @ -8.72%||East @ -5.64%||Is @ -3.48%||Is @ -1.97%||Is @ -0.91%||East @ -0.18%|
|Present value (CN¥, million) discounted at 5.5%||CN¥19.4||CN¥13.2||CN¥10.1||CN¥8.3||CN¥7.2||CN¥6.4||CN¥5.9||CN¥5.5||CN¥5.1||CN¥4.9|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥85m
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount terminal cash flows to present value at a cost of equity of 5.5%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥8.3m × (1 + 1.6%) ÷ (5.5%– 1.6%) = CN¥213m
Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥213m÷ ( 1 + 5.5%)ten= CN¥125m
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 210 million Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Against the current share price of HK$0.2, the company appears around fair value at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Shenzhen Neptunus Interlong Bio-technique 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 into account the debt. In this calculation, we used 5.5%, which is based on a leveraged beta of 0.800. 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.
Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Shenzhen Neptunus Interlong Bio-technique, we have compiled three relevant factors that you should consider in more detail:
- Risks: Every business has them, and we’ve spotted 3 warning signs for Shenzhen Neptunus Interlong Bio-technique (1 of which is a little unpleasant!) that you should know about.
- 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!
- Other environmentally friendly companies: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.
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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.
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