An intrinsic calculation for China BlueChemical Ltd. (HKG: 3983) suggests that it is 45% undervalued

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<p class = "Canvas-Atom Canvas-Text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Did the January share price for China BlueChemical Ltd. (HKG: 3983) consider what it's really worth? Today we will estimate the intrinsic value of the stock by estimating the company's future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. It may sound complicated, but it's actually quite simple! "Data-reactid =" 27 "> Does the share price of China BlueChemical Ltd. (HKG: 3983) in January reflect what it is really worth? Today we will estimate the intrinsic value of the share. I will use the discounted cash flow Use Model (DCF) It may sound complicated, but it's actually quite simple.

<p class = "Canvas Atom Canvas Text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Companies can be valued in a variety of ways We would like to point out that a DCF is not perfect in every situation. If you would like to find out more about discounted cash flow, you can read the reasons for this calculation in the detailed instructions Simply Wall St analysis model, "data-reactid =" 28 "> Companies can be valued in a number of ways, so we would like to point out that a DCF is not suitable for every situation. If you want to learn more about discounted cash flow, the reasons for this can be calculated be read in detail in the Simply Wall St analysis model.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = " Check out our latest analysis for China BlueChemical "data-reactid =" 29 "> Check out our latest analysis for China BlueChemical

The method

We're going to use a two-stage DCF model that, as the name suggests, takes into account two stages of growth. The first phase is generally a longer growth phase that focuses on the final value and is recorded in the second phase of "steady growth". First of all, we have to estimate the cash flows of the next ten years. Wherever possible, we use analyst estimates. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the most recent estimate or the most recently reported value. We expect companies with shrinking free cash flow to slow down their rate of shrinkage and that companies with growing free cash flow will slow down their growth rate during this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

A DCF is all about the idea that a dollar is worth less in the future than a dollar today. Therefore, we discount the value of these future cash flows to the estimated value in today's dollars:

Estimation of 10-year free cash flow (FCF)

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Leverage FCF (CN ¥, million) CN ¥ 1.01b ¥ 1.16 billion ¥ 1.12 billion CN ¥ 1.10b CN ¥ 1.09b CN ¥ 1.09b CN ¥ 1.09b CN ¥ 1.10b ¥ 1.11 billion CN ¥ 1.13 billion
Growth rate Estimated source Analyst x1 Analyst x1 Est @ -3.27% Est @ -1.82% Est @ -0.81% Estimate @ -0.1% Estimate at 0.39% Estimated at 0.74% Estimate at 0.98% Estimated at 1.15%
Present value (CN ¥, million) discounted at 8.5% CN ¥ 932 984 CN ¥ CN ¥ 878 CN ¥ 795 CN ¥ 727 CN ¥ 669 CN ¥ 620 575 CN ¥ 536 CN ¥ CN ¥ 500

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "("Est" = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = CN ¥ 7.2b data-reactid = "36">("Est" = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = CN ¥ 7.2b

After calculating the present value of future cash flows in the first 10-year period, we have to calculate the final value, which takes into account all future cash flows after the first stage. A very conservative growth rate is used for several reasons, which a country's GDP growth cannot exceed. In this case, we used the interest rate on 10-year government bonds (1.6%) to estimate future growth. As in the 10-year growth phase, the future cash flows are discounted to the current value with an equity cost rate of 8.5%.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "Terminal value (TV)= FCF2029 × (1 + g) ÷ (r – g) = CN ¥ 1.1b × (1 + 1.6%) ÷ 8.5% – 1.6%) = CN ¥ 17b data reactide = "38">Terminal value (TV)= FCF2029 × (1 + g) ÷ (r – g) = CN ¥ 1.1b × (1 + 1.6%) ÷ 8.5% – 1.6%) = CN ¥ 17b

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "Present value of the final value (PVTV)= TV / (1 + r)10= CN ¥ 17b ÷ (1 + 8.5%)10= CN ¥ 7.3b data-reactid = "39">Present value of the final value (PVTV)= TV / (1 + r)10= CN ¥ 17b ÷ (1 + 8.5%)10= CN ¥ 7.3b

The total value results from the sum of the cash flows of the next ten years plus the discounted final value, which results in the total equity value, which in this case is CN ¥ 15b. To get the intrinsic value per share, we divide it by the total number of shares issued. Compared to the current share price of HKD 1.9, the company appears to be undervalued at a discount of 45% compared to the current share price. However, keep in mind that this is only an approximate estimate and like any complex formula garbage in, garbage out.

SEHK: 3983 intrinsic value, January 4, 2020

Important assumptions

The most important parameters for a discounted cash flow are now the discount rate and, of course, the actual cash flows. If you disagree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the potential cyclicality of an industry or the future capital requirements of a company and therefore does not provide a complete overview of a company's potential performance. Given that we consider China BlueChemical to be potential shareholders, the cost of equity is used as the discount rate, not the cost of capital (or weighted average cost of capital, WACC) that make up debt. We used 8.5% in this calculation, which is based on a debt beta of 1.092. Beta is a measure of the volatility of a share compared to the overall market. We get our beta from the industry-standard beta of globally comparable companies with a defined limit between 0.8 and 2.0, which is an appropriate range for stable business.

Next Steps:

Valuation is just one side of the coin in creating your investment thesis and shouldn't be the only metric you consider when researching a company. The DCF model is not a perfect tool for stock valuation. Rather, it should serve as a guide to "What assumptions must be made for this stock to be under or overvalued?" If a company grows at a different growth rate or if the cost of equity or risk-free interest rates changes significantly, the output can look very different. What is the reason why the stock price differs from the intrinsic value? For China BlueChemical, I have put together three other factors that you should consider:

  1. Financial health: Does 3983 have a healthy balance sheet? Check out our free balance sheet analysis with six simple reviews of key factors such as leverage and risk.
  2. Future result: What is the growth rate of 3983 compared to its competitors and the broader market? Find out more about analyst consensus numbers for the coming years by accessing our free graph of analyst growth expectations.
  3. Other high quality alternatives: Are there any other high quality stocks you could hold instead of 3983? Check out our interactive list of high quality stocks to get an idea of ​​what else is missing!

<p class = "canvas-atom canvas-text MB (1.0em) MB (0) – SM MB (0.8em) – SM" type = "text" content = "PS. Simply Wall St updates its DCF calculation for each HK stock every day, so if you just want to find the intrinsic value of another stock Search here, "data-reactid =" 65 "> PS. Simply Wall St updates its DCF calculation for each HK share daily, so if you want to determine the intrinsic value of another share, just search here.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "If you discover an error that justifies a correction, please contact the editorial team at editorial-team@simplywallst.com, This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Simply Wall St has no position in the stocks mentioned.

We strive to provide you with long-term, focused research analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Thank you for reading."data-reactid =" 66 ">If you discover an error that justifies a correction, please contact the editorial team at editorial-team@simplywallst.com. This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Simply Wall St has no position in the stocks mentioned.

We strive to provide you with long-term, focused research analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Thank you for reading.