Calculating The Fair Value Of Peijia Medical Limited (HKG:9996)

Key Insights

• Peijia Medical's estimated fair value is HK$7.70 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$8.32 suggests Peijia Medical is potentially trading close to its fair value
• Our fair value estimate is 42% lower than Peijia Medical's analyst price target of CN¥13.38

In this article we are going to estimate the intrinsic value of Peijia Medical Limited (HKG:9996) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. 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 Peijia Medical

The Model

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	-CN¥277.3m	-CN¥173.7m	-CN¥40.0m	CN¥114.7m	CN¥184.8m	CN¥264.8m	CN¥346.6m	CN¥423.3m	CN¥491.2m	CN¥549.1m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x3	Analyst x3	Est @ 61.13%	Est @ 43.33%	Est @ 30.87%	Est @ 22.15%	Est @ 16.04%	Est @ 11.77%
Present Value (CN¥, Millions) Discounted @ 8.3%	-CN¥256	-CN¥148	-CN¥31.5	CN¥83.5	CN¥124	CN¥165	CN¥199	CN¥224	CN¥241	CN¥248

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥849m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥549m× (1 + 1.8%) ÷ (8.3%– 1.8%) = CN¥8.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥8.7b÷ ( 1 + 8.3%)¹⁰= CN¥3.9b

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¥4.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$8.3, 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 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 8.3%, which is based on a levered beta of 0.902. 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

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Peijia Medical, we've compiled three additional items you should assess:

1. Risks: As an example, we've found 1 warning sign for Peijia Medical that you need to consider 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. 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.