A Look At The Intrinsic Value Of Shenzhen King Brother Electronics Technology Co.,Ltd. (SZSE:301041)

Key Insights

• The projected fair value for Shenzhen King Brother Electronics TechnologyLtd is CN¥23.89 based on 2 Stage Free Cash Flow to Equity
• Shenzhen King Brother Electronics TechnologyLtd's CN¥26.77 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -423%, Shenzhen King Brother Electronics TechnologyLtd's competitors seem to be trading at a greater premium to fair value

Does the June share price for Shenzhen King Brother Electronics Technology Co.,Ltd. (SZSE:301041) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 King Brother Electronics TechnologyLtd

The Model

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 begin with, we have to get estimates of 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥75.0m	CN¥99.2m	CN¥122.5m	CN¥143.7m	CN¥162.4m	CN¥178.5m	CN¥192.5m	CN¥204.8m	CN¥215.7m	CN¥225.6m
Growth Rate Estimate Source	Est @ 44.90%	Est @ 32.30%	Est @ 23.48%	Est @ 17.31%	Est @ 12.98%	Est @ 9.96%	Est @ 7.84%	Est @ 6.36%	Est @ 5.32%	Est @ 4.59%
Present Value (CN¥, Millions) Discounted @ 9.0%	CN¥68.8	CN¥83.4	CN¥94.5	CN¥102	CN¥105	CN¥106	CN¥105	CN¥102	CN¥98.9	CN¥94.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥961m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 9.0%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥226m× (1 + 2.9%) ÷ (9.0%– 2.9%) = CN¥3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.8b÷ ( 1 + 9.0%)¹⁰= CN¥1.6b

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¥2.5b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥26.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 King Brother Electronics TechnologyLtd 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 9.0%, which is based on a levered beta of 1.092. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 Shenzhen King Brother Electronics TechnologyLtd, there are three essential aspects you should assess:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen King Brother Electronics TechnologyLtd , and understanding them should be part of your investment process.
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.