A Look At The Fair Value Of Improve Medical Instruments Co., Ltd. (SZSE:300030)

Key Insights

• Improve Medical Instruments' estimated fair value is CN¥4.05 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥4.03 suggests Improve Medical Instruments is potentially trading close to its fair value
• The average premium for Improve Medical Instruments' competitorsis currently 1,602%

In this article we are going to estimate the intrinsic value of Improve Medical Instruments Co., Ltd. (SZSE:300030) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Improve Medical Instruments

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. 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, 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¥67.6m	CN¥72.2m	CN¥76.2m	CN¥79.9m	CN¥83.2m	CN¥86.4m	CN¥89.5m	CN¥92.5m	CN¥95.4m	CN¥98.4m
Growth Rate Estimate Source	Est @ 8.38%	Est @ 6.73%	Est @ 5.58%	Est @ 4.78%	Est @ 4.21%	Est @ 3.82%	Est @ 3.54%	Est @ 3.35%	Est @ 3.22%	Est @ 3.12%
Present Value (CN¥, Millions) Discounted @ 8.9%	CN¥62.1	CN¥60.9	CN¥59.1	CN¥56.8	CN¥54.4	CN¥51.9	CN¥49.3	CN¥46.8	CN¥44.4	CN¥42.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥528m

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. 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 8.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥98m× (1 + 2.9%) ÷ (8.9%– 2.9%) = CN¥1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.7b÷ ( 1 + 8.9%)¹⁰= CN¥725m

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¥1.3b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥4.0, the company appears about fair value at a 0.6% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Improve Medical Instruments 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 8.9%, which is based on a levered beta of 1.061. 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 Improve Medical Instruments, there are three further factors you should consider:

1. Risks: Every company has them, and we've spotted 2 warning signs for Improve Medical Instruments (of which 1 can't be ignored!) you should know about.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.