Stock Analysis

MicroPort Scientific Corporation's (HKG:853) Intrinsic Value Is Potentially 45% Above Its Share Price

SEHK:853
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, MicroPort Scientific fair value estimate is HK$18.03
  • MicroPort Scientific is estimated to be 31% undervalued based on current share price of HK$12.44
  • The US$21.73 analyst price target for 853 is 21% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of MicroPort Scientific Corporation (HKG:853) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for MicroPort Scientific

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. 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.

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) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) -US$406.7m -US$253.5m US$11.0m US$104.0m US$172.1m US$252.0m US$335.3m US$414.8m US$485.9m US$547.0m
Growth Rate Estimate Source Analyst x3 Analyst x2 Analyst x1 Analyst x1 Est @ 65.50% Est @ 46.41% Est @ 33.05% Est @ 23.70% Est @ 17.15% Est @ 12.57%
Present Value ($, Millions) Discounted @ 8.7% -US$374 -US$215 US$8.6 US$74.6 US$114 US$153 US$187 US$213 US$230 US$238

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$630m

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$547m× (1 + 1.9%) ÷ (8.7%– 1.9%) = US$8.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$8.2b÷ ( 1 + 8.7%)10= US$3.6b

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 US$4.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$12.4, the company appears quite undervalued at a 31% discount to where the stock price trades currently. 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.

dcf
SEHK:853 Discounted Cash Flow September 8th 2023

The Assumptions

We would point out that 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 MicroPort Scientific 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 8.7%, which is based on a levered beta of 1.117. 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 MicroPort Scientific

Strength
  • Debt is well covered by earnings.
Weakness
  • No major weaknesses identified for 853.
Opportunity
  • Forecast to reduce losses next year.
  • Good value based on P/S ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Has less than 3 years of cash runway based on current free cash flow.
  • Not expected to become profitable over the next 3 years.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For MicroPort Scientific, there are three essential factors you should look at:

  1. Risks: Take risks, for example - MicroPort Scientific has 1 warning sign we think you should be aware of.
  2. Future Earnings: How does 853'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.

Valuation is complex, but we're helping make it simple.

Find out whether MicroPort Scientific is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.