A Look At The Intrinsic Value Of Guangzhou Risong Intelligent Technology Holding Co., Ltd. (SHSE:688090)

Key Insights

• The projected fair value for Guangzhou Risong Intelligent Technology Holding is CN¥48.78 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥44.36 suggests Guangzhou Risong Intelligent Technology Holding is potentially trading close to its fair value
• Guangzhou Risong Intelligent Technology Holding's peers are currently trading at a premium of 439% on average

Does the September share price for Guangzhou Risong Intelligent Technology Holding Co., Ltd. (SHSE:688090) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Guangzhou Risong Intelligent Technology Holding

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

Generally we assume that a dollar today is more valuable 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥65.8m	CN¥100.9m	CN¥139.4m	CN¥177.8m	CN¥213.7m	CN¥245.7m	CN¥273.5m	CN¥297.5m	CN¥318.4m	CN¥336.7m
Growth Rate Estimate Source	Est @ 74.94%	Est @ 53.32%	Est @ 38.18%	Est @ 27.58%	Est @ 20.16%	Est @ 14.97%	Est @ 11.33%	Est @ 8.79%	Est @ 7.01%	Est @ 5.76%
Present Value (CN¥, Millions) Discounted @ 7.9%	CN¥61.0	CN¥86.7	CN¥111	CN¥131	CN¥146	CN¥156	CN¥161	CN¥162	CN¥161	CN¥158

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.3b

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. 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 7.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥337m× (1 + 2.9%) ÷ (7.9%– 2.9%) = CN¥6.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥6.9b÷ ( 1 + 7.9%)¹⁰= CN¥3.2b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥4.6b. 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¥44.4, the company appears about fair value at a 9.1% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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. 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 Guangzhou Risong Intelligent Technology Holding 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 7.9%, which is based on a levered beta of 1.009. 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 Guangzhou Risong Intelligent Technology Holding

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for 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 significantly impact the valuation. For Guangzhou Risong Intelligent Technology Holding, we've put together three pertinent factors you should look at:

1. Risks: For instance, we've identified 3 warning signs for Guangzhou Risong Intelligent Technology Holding (2 don't sit too well with us) you should be aware of.
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.