A Look At The Intrinsic Value Of Kingsoft Corporation Limited (HKG:3888)

Key Insights

• Kingsoft's estimated fair value is HK$30.33 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$35.45 suggests Kingsoft is potentially trading close to its fair value
• Analyst price target for 3888 is CN¥37.60, which is 24% above our fair value estimate

In this article we are going to estimate the intrinsic value of Kingsoft Corporation Limited (HKG:3888) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Kingsoft

Is Kingsoft 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. 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥1.57b	CN¥2.06b	CN¥2.47b	CN¥2.63b	CN¥2.77b	CN¥2.89b	CN¥2.99b	CN¥3.08b	CN¥3.16b	CN¥3.23b
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ 6.75%	Est @ 5.25%	Est @ 4.20%	Est @ 3.46%	Est @ 2.94%	Est @ 2.58%	Est @ 2.33%
Present Value (CN¥, Millions) Discounted @ 8.9%	CN¥1.4k	CN¥1.7k	CN¥1.9k	CN¥1.9k	CN¥1.8k	CN¥1.7k	CN¥1.6k	CN¥1.6k	CN¥1.5k	CN¥1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥17b

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 (1.7%) 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 8.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥3.2b× (1 + 1.7%) ÷ (8.9%– 1.7%) = CN¥46b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥46b÷ ( 1 + 8.9%)¹⁰= CN¥20b

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¥36b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$35.5, the company appears around fair value at the time of writing. 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Kingsoft 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 8.9%, which is based on a levered beta of 1.029. 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 Kingsoft

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Kingsoft, we've put together three fundamental elements you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Kingsoft , and understanding it should be part of your investment process.
2. Future Earnings: How does 3888'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.