A Look At The Intrinsic Value Of Sensteed Hi-Tech Group (SZSE:000981)

Key Insights

• Sensteed Hi-Tech Group's estimated fair value is CN¥1.06 based on 2 Stage Free Cash Flow to Equity
• Sensteed Hi-Tech Group's CN¥1.11 share price indicates it is trading at similar levels as its fair value estimate
• Industry average of 5,433% suggests Sensteed Hi-Tech Group's peers are currently trading at a higher premium to fair value

Today we will run through one way of estimating the intrinsic value of Sensteed Hi-Tech Group (SZSE:000981) by taking the forecast future cash flows of the company and discounting them back to today's value. 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Sensteed Hi-Tech Group

Crunching The Numbers

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 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥298.5m	CN¥408.4m	CN¥517.2m	CN¥618.0m	CN¥707.6m	CN¥785.5m	CN¥852.7m	CN¥911.1m	CN¥962.6m	CN¥1.01b
Growth Rate Estimate Source	Est @ 51.37%	Est @ 36.82%	Est @ 26.63%	Est @ 19.49%	Est @ 14.50%	Est @ 11.01%	Est @ 8.56%	Est @ 6.85%	Est @ 5.65%	Est @ 4.81%
Present Value (CN¥, Millions) Discounted @ 9.8%	CN¥272	CN¥339	CN¥391	CN¥426	CN¥444	CN¥449	CN¥444	CN¥432	CN¥416	CN¥397

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥4.0b

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 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.0b× (1 + 2.9%) ÷ (9.8%– 2.9%) = CN¥15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥15b÷ ( 1 + 9.8%)¹⁰= CN¥5.9b

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¥9.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥1.1, the company appears around fair value at the time of writing. 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.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Sensteed Hi-Tech Group 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 9.8%, which is based on a levered beta of 1.389. 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.

SWOT Analysis for Sensteed Hi-Tech Group

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sensteed Hi-Tech Group, we've compiled three relevant elements you should further examine:

1. Risks: For example, we've discovered 2 warning signs for Sensteed Hi-Tech Group (1 is potentially serious!) that you should be aware of before investing here.
2. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.

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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.