Nine Dragons Paper (Holdings) Limited (HKG:2689) Shares Could Be 43% Below Their Intrinsic Value Estimate

Key Insights

• Nine Dragons Paper (Holdings)'s estimated fair value is HK$8.47 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$4.81 suggests Nine Dragons Paper (Holdings) is potentially 43% undervalued
• The CN¥6.07 analyst price target for 2689 is 28% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Nine Dragons Paper (Holdings) Limited (HKG:2689) by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Nine Dragons Paper (Holdings)

Is Nine Dragons Paper (Holdings) Fairly Valued?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 (CN¥, Millions)	-CN¥905.5m	CN¥1.31b	CN¥2.35b	CN¥3.65b	CN¥5.10b	CN¥6.53b	CN¥7.86b	CN¥9.02b	CN¥10.00b	CN¥10.8b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 78.80%	Est @ 55.70%	Est @ 39.53%	Est @ 28.21%	Est @ 20.29%	Est @ 14.74%	Est @ 10.86%	Est @ 8.14%
Present Value (CN¥, Millions) Discounted @ 16%	-CN¥780	CN¥973	CN¥1.5k	CN¥2.0k	CN¥2.4k	CN¥2.7k	CN¥2.8k	CN¥2.7k	CN¥2.6k	CN¥2.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥19b

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥11b× (1 + 1.8%) ÷ (16%– 1.8%) = CN¥77b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥77b÷ ( 1 + 16%)¹⁰= CN¥17b

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¥37b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$4.8, the company appears quite undervalued at a 43% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important 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. 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 16%, 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Nine Dragons Paper (Holdings), we've compiled three additional aspects you should further examine:

1. Risks: For example, we've discovered 1 warning sign for Nine Dragons Paper (Holdings) that you should be aware of before investing here.
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 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. 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.