Estimating The Intrinsic Value Of Hangzhou Silan Microelectronics Co.,Ltd (SHSE:600460)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Hangzhou Silan MicroelectronicsLtd fair value estimate is CN¥18.39
• Current share price of CN¥18.44 suggests Hangzhou Silan MicroelectronicsLtd is potentially trading close to its fair value
• Our fair value estimate is 11% lower than Hangzhou Silan MicroelectronicsLtd's analyst price target of CN¥20.60

Does the September share price for Hangzhou Silan Microelectronics Co.,Ltd (SHSE:600460) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for Hangzhou Silan MicroelectronicsLtd

The Calculation

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. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥166.5m	CN¥535.0m	CN¥901.8m	CN¥1.34b	CN¥1.81b	CN¥2.27b	CN¥2.70b	CN¥3.07b	CN¥3.40b	CN¥3.68b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 68.55%	Est @ 48.84%	Est @ 35.04%	Est @ 25.39%	Est @ 18.63%	Est @ 13.89%	Est @ 10.58%	Est @ 8.26%
Present Value (CN¥, Millions) Discounted @ 10%	CN¥151	CN¥442	CN¥677	CN¥916	CN¥1.1k	CN¥1.3k	CN¥1.4k	CN¥1.4k	CN¥1.4k	CN¥1.4k

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

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 10%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥3.7b× (1 + 2.9%) ÷ (10%– 2.9%) = CN¥53b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥53b÷ ( 1 + 10%)¹⁰= CN¥20b

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¥31b. 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¥18.4, 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.

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. 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 Hangzhou Silan MicroelectronicsLtd 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 10%, which is based on a levered beta of 1.438. 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 Hangzhou Silan MicroelectronicsLtd

Looking Ahead:

Whilst important, the DCF calculation 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. 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. 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 Hangzhou Silan MicroelectronicsLtd, we've put together three relevant items you should further research:

1. Risks: For example, we've discovered 2 warning signs for Hangzhou Silan MicroelectronicsLtd that you should be aware of before investing here.
2. Future Earnings: How does 600460's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. 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!

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.