A Look At The Intrinsic Value Of Shandong Weigao Group Medical Polymer Company Limited (HKG:1066)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Shandong Weigao Group Medical Polymer fair value estimate is HK$12.55
• With HK$13.74 share price, Shandong Weigao Group Medical Polymer appears to be trading close to its estimated fair value
• Our fair value estimate is 28% higher than Shandong Weigao Group Medical Polymer's analyst price target of CN¥16.12

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Shandong Weigao Group Medical Polymer Company Limited (HKG:1066) as an investment opportunity 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. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Shandong Weigao Group Medical Polymer

The Method

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 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, 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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥2.70b	CN¥2.98b	CN¥3.18b	CN¥3.35b	CN¥3.49b	CN¥3.62b	CN¥3.72b	CN¥3.82b	CN¥3.91b	CN¥3.99b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 6.84%	Est @ 5.31%	Est @ 4.24%	Est @ 3.49%	Est @ 2.96%	Est @ 2.60%	Est @ 2.34%	Est @ 2.16%
Present Value (CN¥, Millions) Discounted @ 8.2%	CN¥2.5k	CN¥2.5k	CN¥2.5k	CN¥2.4k	CN¥2.4k	CN¥2.2k	CN¥2.1k	CN¥2.0k	CN¥1.9k	CN¥1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥22b

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥4.0b× (1 + 1.7%) ÷ (8.2%– 1.7%) = CN¥63b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥63b÷ ( 1 + 8.2%)¹⁰= CN¥28b

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¥51b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$13.7, 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Shandong Weigao Group Medical Polymer 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 8.2%, which is based on a levered beta of 0.907. 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 Shandong Weigao Group Medical Polymer

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shandong Weigao Group Medical Polymer, we've put together three additional factors you should further research:

1. Risks: Be aware that Shandong Weigao Group Medical Polymer is showing 1 warning sign in our investment analysis , you should know about...
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 1066's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. Simply Wall St updates its DCF calculation for every Hong Kong 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.