Estimating The Intrinsic Value Of Huafon Microfibre (Shanghai) Co., Ltd. (SZSE:300180)

Key Insights

• Huafon Microfibre (Shanghai)'s estimated fair value is CN¥3.41 based on 2 Stage Free Cash Flow to Equity
• Huafon Microfibre (Shanghai)'s CN¥3.79 share price indicates it is trading at similar levels as its fair value estimate
• Huafon Microfibre (Shanghai)'s peers seem to be trading at a higher premium to fair value based onthe industry average of -319%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Huafon Microfibre (Shanghai) Co., Ltd. (SZSE:300180) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Huafon Microfibre (Shanghai)

The Method

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 start off with, we need to estimate 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥250.1m	CN¥290.1m	CN¥325.1m	CN¥355.5m	CN¥381.8m	CN¥405.0m	CN¥425.8m	CN¥444.8m	CN¥462.7m	CN¥479.8m
Growth Rate Estimate Source	Est @ 21.58%	Est @ 15.99%	Est @ 12.07%	Est @ 9.33%	Est @ 7.41%	Est @ 6.07%	Est @ 5.13%	Est @ 4.47%	Est @ 4.01%	Est @ 3.69%
Present Value (CN¥, Millions) Discounted @ 8.8%	CN¥230	CN¥245	CN¥253	CN¥254	CN¥251	CN¥244	CN¥236	CN¥227	CN¥217	CN¥207

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.4b

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 8.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥480m× (1 + 2.9%) ÷ (8.8%– 2.9%) = CN¥8.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥8.4b÷ ( 1 + 8.8%)¹⁰= CN¥3.6b

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¥6.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥3.8, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Huafon Microfibre (Shanghai) 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 8.8%, which is based on a levered beta of 1.039. 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 Huafon Microfibre (Shanghai)

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Huafon Microfibre (Shanghai), there are three fundamental elements you should further examine:

1. Risks: Take risks, for example - Huafon Microfibre (Shanghai) has 1 warning sign we think 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SZSE every day. If you want to find the calculation for other stocks 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.