Estimating The Intrinsic Value Of Aerospace CH UAV Co.,Ltd (SZSE:002389)

Key Insights

• Aerospace CH UAVLtd's estimated fair value is CN¥16.08 based on 2 Stage Free Cash Flow to Equity
• With CN¥15.63 share price, Aerospace CH UAVLtd appears to be trading close to its estimated fair value
• The CN¥21.60 analyst price target for 2389 is 34% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Aerospace CH UAV Co.,Ltd (SZSE:002389) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Aerospace CH UAVLtd

Is Aerospace CH UAVLtd Fairly Valued?

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥189.6m	CN¥328.2m	CN¥499.0m	CN¥685.1m	CN¥870.0m	CN¥1.04b	CN¥1.20b	CN¥1.33b	CN¥1.44b	CN¥1.54b
Growth Rate Estimate Source	Est @ 103.19%	Est @ 73.10%	Est @ 52.04%	Est @ 37.30%	Est @ 26.98%	Est @ 19.76%	Est @ 14.70%	Est @ 11.16%	Est @ 8.68%	Est @ 6.95%
Present Value (CN¥, Millions) Discounted @ 9.1%	CN¥174	CN¥276	CN¥385	CN¥484	CN¥564	CN¥619	CN¥651	CN¥663	CN¥661	CN¥648

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.1b

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 9.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥1.5b× (1 + 2.9%) ÷ (9.1%– 2.9%) = CN¥26b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥26b÷ ( 1 + 9.1%)¹⁰= CN¥11b

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¥16b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥15.6, the company appears about fair value at a 2.8% discount to where the stock price trades currently. 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

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 Aerospace CH UAVLtd 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 9.1%, which is based on a levered beta of 1.096. 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 Aerospace CH UAVLtd

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Aerospace CH UAVLtd, there are three important factors you should assess:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Aerospace CH UAVLtd .
2. Future Earnings: How does 002389'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 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!

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.

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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.