Stock Analysis

A Look At The Fair Value Of Hanshang Group Co., Ltd. (SHSE:600774)

SHSE:600774
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Hanshang Group fair value estimate is CN¥6.76
  • With CN¥6.73 share price, Hanshang Group appears to be trading close to its estimated fair value
  • Hanshang Group's peers are currently trading at a premium of 12,571% on average

Does the April share price for Hanshang Group Co., Ltd. (SHSE:600774) 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. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

See our latest analysis for Hanshang Group

Crunching The Numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (CN¥, Millions) CN¥108.3m CN¥103.4m CN¥101.1m CN¥100.4m CN¥100.8m CN¥102.0m CN¥103.7m CN¥105.9m CN¥108.3m CN¥111.0m
Growth Rate Estimate Source Est @ -7.65% Est @ -4.47% Est @ -2.25% Est @ -0.69% Est @ 0.40% Est @ 1.16% Est @ 1.69% Est @ 2.07% Est @ 2.33% Est @ 2.51%
Present Value (CN¥, Millions) Discounted @ 7.4% CN¥101 CN¥89.6 CN¥81.5 CN¥75.4 CN¥70.4 CN¥66.3 CN¥62.7 CN¥59.6 CN¥56.8 CN¥54.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥717m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥111m× (1 + 2.9%) ÷ (7.4%– 2.9%) = CN¥2.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥2.5b÷ ( 1 + 7.4%)10= CN¥1.2b

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¥2.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥6.7, the company appears about fair value at a 0.5% discount to where the stock price trades currently. 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.

dcf
SHSE:600774 Discounted Cash Flow April 16th 2024

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 Hanshang 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 7.4%, which is based on a levered beta of 0.800. 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 Hanshang Group

Strength
  • Debt is well covered by cash flow.
Weakness
  • Earnings declined over the past year.
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
Opportunity
  • Current share price is below our estimate of fair value.
  • Lack of analyst coverage makes it difficult to determine 600774's earnings prospects.
Threat
  • Dividends are not covered by cash flow.

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Hanshang Group, we've compiled three fundamental items you should further research:

  1. Risks: For example, we've discovered 3 warning signs for Hanshang Group 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.

Valuation is complex, but we're helping make it simple.

Find out whether Hanshang Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.