Estimating The Intrinsic Value Of HeNan Splendor Science & Technology Co., Ltd. (SZSE:002296)

Key Insights

• The projected fair value for HeNan Splendor Science & Technology is CN¥9.48 based on 2 Stage Free Cash Flow to Equity
• HeNan Splendor Science & Technology's CN¥10.77 share price indicates it is trading at similar levels as its fair value estimate
• HeNan Splendor Science & Technology's peers seem to be trading at a higher premium to fair value based onthe industry average of -5,175%

How far off is HeNan Splendor Science & Technology Co., Ltd. (SZSE:002296) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for HeNan Splendor Science & Technology

The Calculation

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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥167.5m	CN¥174.0m	CN¥180.2m	CN¥186.2m	CN¥192.1m	CN¥198.0m	CN¥203.9m	CN¥209.8m	CN¥215.9m	CN¥222.1m
Growth Rate Estimate Source	Est @ 4.34%	Est @ 3.88%	Est @ 3.55%	Est @ 3.33%	Est @ 3.17%	Est @ 3.06%	Est @ 2.98%	Est @ 2.93%	Est @ 2.89%	Est @ 2.86%
Present Value (CN¥, Millions) Discounted @ 7.5%	CN¥156	CN¥151	CN¥145	CN¥140	CN¥134	CN¥128	CN¥123	CN¥118	CN¥113	CN¥108

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.3b

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 (2.8%) 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 7.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥222m× (1 + 2.8%) ÷ (7.5%– 2.8%) = CN¥4.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥4.9b÷ ( 1 + 7.5%)¹⁰= CN¥2.4b

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¥3.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥10.8, the company appears around fair value at the time of writing. 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.

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 HeNan Splendor Science & Technology 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 7.5%, which is based on a levered beta of 0.938. 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.

Next Steps:

Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For HeNan Splendor Science & Technology, we've put together three essential aspects you should explore:

1. Risks: We feel that you should assess the 1 warning sign for HeNan Splendor Science & Technology we've flagged before making an investment in the company.
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.

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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.