Calculating The Intrinsic Value Of Nine Dragons Paper (Holdings) Limited (HKG:2689)

Key Insights

• The projected fair value for Nine Dragons Paper (Holdings) is HK$3.30 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$3.45 suggests Nine Dragons Paper (Holdings) is potentially trading close to its fair value
• Analyst price target for 2689 is CN¥4.33, which is 31% above our fair value estimate

In this article we are going to estimate the intrinsic value of Nine Dragons Paper (Holdings) Limited (HKG:2689) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Nine Dragons Paper (Holdings)

The Model

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

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	-CN¥3.14b	CN¥2.25b	CN¥2.14b	CN¥2.08b	CN¥2.06b	CN¥2.06b	CN¥2.07b	CN¥2.09b	CN¥2.12b	CN¥2.16b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ -2.58%	Est @ -1.13%	Est @ -0.12%	Est @ 0.59%	Est @ 1.09%	Est @ 1.44%	Est @ 1.68%
Present Value (CN¥, Millions) Discounted @ 12%	-CN¥2.8k	CN¥1.8k	CN¥1.5k	CN¥1.3k	CN¥1.2k	CN¥1.0k	CN¥924	CN¥833	CN¥753	CN¥682

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥7.2b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥2.2b× (1 + 2.3%) ÷ (12%– 2.3%) = CN¥22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥22b÷ ( 1 + 12%)¹⁰= CN¥7.0b

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¥14b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$3.5, 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. 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 Nine Dragons Paper (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 12%, which is based on a levered beta of 2.000. 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 Nine Dragons Paper (Holdings)

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Nine Dragons Paper (Holdings), we've compiled three important items you should further examine:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Nine Dragons Paper (Holdings) , and understanding it should be part of your investment process.
2. Future Earnings: How does 2689'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.