A Look At The Intrinsic Value Of Sinco Pharmaceuticals Holdings Limited (HKG:6833)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Sinco Pharmaceuticals Holdings fair value estimate is HK$0.26
• Sinco Pharmaceuticals Holdings' HK$0.28 share price indicates it is trading at similar levels as its fair value estimate
• Sinco Pharmaceuticals Holdings' peers seem to be trading at a higher premium to fair value based onthe industry average of -90%

Does the June share price for Sinco Pharmaceuticals Holdings Limited (HKG:6833) 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. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Sinco Pharmaceuticals Holdings

Crunching The Numbers

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥40.6m	CN¥36.5m	CN¥34.2m	CN¥32.9m	CN¥32.1m	CN¥31.8m	CN¥31.8m	CN¥31.9m	CN¥32.2m	CN¥32.5m
Growth Rate Estimate Source	Est @ -14.90%	Est @ -9.89%	Est @ -6.38%	Est @ -3.93%	Est @ -2.21%	Est @ -1.01%	Est @ -0.17%	Est @ 0.42%	Est @ 0.84%	Est @ 1.13%
Present Value (CN¥, Millions) Discounted @ 7.9%	CN¥37.6	CN¥31.4	CN¥27.2	CN¥24.2	CN¥21.9	CN¥20.1	CN¥18.6	CN¥17.3	CN¥16.2	CN¥15.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥230m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥33m× (1 + 1.8%) ÷ (7.9%– 1.8%) = CN¥540m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥540m÷ ( 1 + 7.9%)¹⁰= CN¥252m

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¥481m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.3, 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.

Important Assumptions

Now 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 Sinco Pharmaceuticals Holdings 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 0.856. 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:

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. 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 Sinco Pharmaceuticals Holdings, there are three additional factors you should further examine:

1. Risks: To that end, you should be aware of the 3 warning signs we've spotted with Sinco Pharmaceuticals Holdings .
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. 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.