Calculating The Intrinsic Value Of Shenzhen Sunmoon Microelectronics Co., Ltd (SHSE:688699)

Key Insights

• The projected fair value for Shenzhen Sunmoon Microelectronics is CN¥24.63 based on 2 Stage Free Cash Flow to Equity
• Shenzhen Sunmoon Microelectronics' CN¥27.20 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -1,258%, Shenzhen Sunmoon Microelectronics' competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of Shenzhen Sunmoon Microelectronics Co., Ltd (SHSE:688699) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

View our latest analysis for Shenzhen Sunmoon Microelectronics

Step By Step Through 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. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥213.2m	CN¥216.9m	CN¥221.4m	CN¥226.5m	CN¥232.1m	CN¥238.2m	CN¥244.7m	CN¥251.4m	CN¥258.5m	CN¥265.8m
Growth Rate Estimate Source	Est @ 1.21%	Est @ 1.72%	Est @ 2.07%	Est @ 2.32%	Est @ 2.49%	Est @ 2.62%	Est @ 2.70%	Est @ 2.76%	Est @ 2.80%	Est @ 2.83%
Present Value (CN¥, Millions) Discounted @ 11%	CN¥193	CN¥177	CN¥164	CN¥152	CN¥141	CN¥130	CN¥121	CN¥113	CN¥105	CN¥97.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.4b

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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥266m× (1 + 2.9%) ÷ (11%– 2.9%) = CN¥3.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.6b÷ ( 1 + 11%)¹⁰= CN¥1.3b

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¥2.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥27.2, 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

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 Shenzhen Sunmoon Microelectronics 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 11%, which is based on a levered beta of 1.361. 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 Shenzhen Sunmoon Microelectronics

Moving On:

Although the valuation of a company is important, it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shenzhen Sunmoon Microelectronics, we've compiled three important aspects you should look at:

1. Risks: For instance, we've identified 1 warning sign for Shenzhen Sunmoon Microelectronics that you should be aware of.
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 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.

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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.