Is Yihai International Holding Ltd. (HKG:1579) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

• Yihai International Holding's estimated fair value is HK$18.69 based on 2 Stage Free Cash Flow to Equity
• Yihai International Holding is estimated to be 28% overvalued based on current share price of HK$24.00
• The CN¥24.28 analyst price target for 1579 is 30% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Yihai International Holding Ltd. (HKG:1579) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 Yihai International Holding

The Calculation

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 begin with, we have to get estimates of the next ten years of cash flows. 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

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥6.2b

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥1.2b× (1 + 1.7%) ÷ (7.5%– 1.7%) = CN¥20b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥20b÷ ( 1 + 7.5%)¹⁰= CN¥9.9b

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. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$24.0, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important 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 Yihai International Holding 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 0.800. 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 Yihai International Holding

Looking Ahead:

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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Yihai International Holding, we've put together three pertinent elements you should look at:

1. Financial Health: Does 1579 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does 1579'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK 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.