A Look At The Fair Value Of China BlueChemical Ltd. (HKG:3983)

By
Simply Wall St
Published
August 22, 2021
SEHK:3983
Source: Shutterstock

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of China BlueChemical Ltd. (HKG:3983) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for China BlueChemical

What's the estimated valuation?

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, 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) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (CN¥, Millions) CN¥765.9m CN¥656.4m CN¥593.5m CN¥556.4m CN¥534.5m CN¥522.2m CN¥516.1m CN¥514.1m CN¥515.0m CN¥518.0m
Growth Rate Estimate Source Est @ -21.07% Est @ -14.3% Est @ -9.57% Est @ -6.25% Est @ -3.93% Est @ -2.31% Est @ -1.17% Est @ -0.38% Est @ 0.18% Est @ 0.57%
Present Value (CN¥, Millions) Discounted @ 7.2% CN¥714 CN¥571 CN¥482 CN¥421 CN¥377 CN¥344 CN¥317 CN¥295 CN¥275 CN¥258

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥4.1b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CN¥518m× (1 + 1.5%) ÷ (7.2%– 1.5%) = CN¥9.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥9.2b÷ ( 1 + 7.2%)10= CN¥4.6b

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 CN¥8.6b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$2.4, 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.

dcf
SEHK:3983 Discounted Cash Flow August 23rd 2021

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. 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 China BlueChemical 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 7.2%, which is based on a levered beta of 1.060. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 China BlueChemical, we've compiled three relevant elements you should further research:

  1. Risks: As an example, we've found 1 warning sign for China BlueChemical that you need to consider before investing here.
  2. Future Earnings: How does 3983'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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