Are Investors Undervaluing Peijia Medical Limited (HKG:9996) By 40%?

Key Insights

• Peijia Medical's estimated fair value is CN¥19.2 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥11.5 suggests Peijia Medical is 40% undervalued
• Analyst price target for 9996 is CN¥10.64 which is 45% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Peijia Medical Limited (HKG:9996) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

See our latest analysis for Peijia Medical

The Calculation

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 start off with, we need to estimate 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	-CN¥341.0m	-CN¥175.7m	-CN¥84.7m	CN¥82.3m	CN¥253.3m	CN¥420.9m	CN¥617.8m	CN¥823.1m	CN¥1.02b	CN¥1.19b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x3	Analyst x3	Est @ 66.14%	Est @ 46.78%	Est @ 33.23%	Est @ 23.75%	Est @ 17.11%
Present Value (CN¥, Millions) Discounted @ 7.8%	-CN¥316	-CN¥151	-CN¥67.6	CN¥61.0	CN¥174	CN¥269	CN¥366	CN¥452	CN¥519	CN¥564

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥1.9b

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 (1.6%) 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 7.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥1.2b× (1 + 1.6%) ÷ (7.8%– 1.6%) = CN¥20b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥20b÷ ( 1 + 7.8%)¹⁰= CN¥9.3b

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¥11b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$11.5, the company appears quite undervalued at a 40% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Peijia Medical 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 7.8%, which is based on a levered beta of 0.880. 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 Peijia Medical

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. What is the reason for the share price sitting below the intrinsic value? For Peijia Medical, there are three additional aspects you should look at:

1. Risks: For example, we've discovered 1 warning sign for Peijia Medical that you should be aware of before investing here.
2. Future Earnings: How does 9996'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 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.