Estimating The Fair Value Of Wenzhou Kangning Hospital Co., Ltd. (HKG:2120)

Key Insights

• Wenzhou Kangning Hospital's estimated fair value is HK$12.02 based on 2 Stage Free Cash Flow to Equity
• Wenzhou Kangning Hospital's HK$10.28 share price indicates it is trading at similar levels as its fair value estimate
• Wenzhou Kangning Hospital's peers are currently trading at a premium of 459% on average

How far off is Wenzhou Kangning Hospital Co., Ltd. (HKG:2120) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Wenzhou Kangning Hospital

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 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¥46.4m	CN¥48.2m	CN¥49.8m	CN¥51.2m	CN¥52.6m	CN¥53.9m	CN¥55.1m	CN¥56.4m	CN¥57.6m	CN¥58.8m
Growth Rate Estimate Source	Est @ 4.58%	Est @ 3.82%	Est @ 3.28%	Est @ 2.91%	Est @ 2.65%	Est @ 2.47%	Est @ 2.34%	Est @ 2.25%	Est @ 2.19%	Est @ 2.14%
Present Value (CN¥, Millions) Discounted @ 7.9%	CN¥43.0	CN¥41.4	CN¥39.6	CN¥37.7	CN¥35.9	CN¥34.1	CN¥32.3	CN¥30.6	CN¥29.0	CN¥27.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥351m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥59m× (1 + 2.0%) ÷ (7.9%– 2.0%) = CN¥1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥1.0b÷ ( 1 + 7.9%)¹⁰= CN¥474m

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¥825m. 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$10.3, the company appears about fair value at a 15% 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. 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 Wenzhou Kangning Hospital 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 7.9%, which is based on a levered beta of 1.048. 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 Wenzhou Kangning Hospital

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 Wenzhou Kangning Hospital, we've compiled three essential factors you should further research:

1. Risks: We feel that you should assess the 2 warning signs for Wenzhou Kangning Hospital (1 doesn't sit too well with us!) we've flagged before making an investment in the company.
2. 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!
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 Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.