Stock Analysis

Calculating The Intrinsic Value Of Hangzhou Hikvision Digital Technology Co., Ltd. (SZSE:002415)

SZSE:002415
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Key Insights

In this article we are going to estimate the intrinsic value of Hangzhou Hikvision Digital Technology Co., Ltd. (SZSE:002415) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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 Hangzhou Hikvision Digital Technology

Crunching The Numbers

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. 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, 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¥11.6b CN¥14.4b CN¥16.8b CN¥18.9b CN¥22.5b CN¥25.0b CN¥27.1b CN¥29.0b CN¥30.6b CN¥32.1b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Analyst x1 Analyst x1 Est @ 11.05% Est @ 8.61% Est @ 6.89% Est @ 5.70% Est @ 4.86%
Present Value (CN¥, Millions) Discounted @ 9.3% CN¥10.7k CN¥12.0k CN¥12.9k CN¥13.2k CN¥14.4k CN¥14.7k CN¥14.6k CN¥14.3k CN¥13.8k CN¥13.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥134b

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 9.3%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥32b× (1 + 2.9%) ÷ (9.3%– 2.9%) = CN¥519b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥519b÷ ( 1 + 9.3%)10= CN¥214b

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¥348b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥33.6, the company appears about fair value at a 9.8% 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.

dcf
SZSE:002415 Discounted Cash Flow May 8th 2024

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. 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 Hangzhou Hikvision Digital 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 9.3%, which is based on a levered beta of 1.130. 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 Hikvision Digital Technology

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • No major weaknesses identified for 002415.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the Chinese market.

Next Steps:

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. 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 Hangzhou Hikvision Digital Technology, there are three fundamental items you should further examine:

  1. Risks: Take risks, for example - Hangzhou Hikvision Digital Technology has 1 warning sign we think you should be aware of.
  2. Future Earnings: How does 002415'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.

Valuation is complex, but we're here to simplify it.

Discover if Hangzhou Hikvision Digital Technology might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.