Sino Biopharmaceutical Limited's (HKG:1177) Intrinsic Value Is Potentially 34% Above Its Share Price
Key Insights
- The projected fair value for Sino Biopharmaceutical is HK$4.22 based on 2 Stage Free Cash Flow to Equity
- Current share price of HK$3.15 suggests Sino Biopharmaceutical is potentially 25% undervalued
- The CN¥4.92 analyst price target for 1177 is 17% more than our estimate of fair value
Does the March share price for Sino Biopharmaceutical Limited (HKG:1177) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them 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!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Sino Biopharmaceutical
The Method
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, 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
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (CN¥, Millions) | CN¥5.06b | CN¥5.30b | CN¥5.28b | CN¥3.78b | CN¥3.95b | CN¥3.64b | CN¥3.46b | CN¥3.37b | CN¥3.32b | CN¥3.31b |
Growth Rate Estimate Source | Analyst x7 | Analyst x7 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ -7.86% | Est @ -4.89% | Est @ -2.81% | Est @ -1.35% | Est @ -0.34% |
Present Value (CN¥, Millions) Discounted @ 6.4% | CN¥4.8k | CN¥4.7k | CN¥4.4k | CN¥2.9k | CN¥2.9k | CN¥2.5k | CN¥2.2k | CN¥2.0k | CN¥1.9k | CN¥1.8k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥30b
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 (2.0%) 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 6.4%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥3.3b× (1 + 2.0%) ÷ (6.4%– 2.0%) = CN¥77b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥77b÷ ( 1 + 6.4%)10= CN¥41b
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¥71b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$3.2, the company appears a touch undervalued at a 25% discount to where the stock price trades currently. 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 Sino Biopharmaceutical 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 6.4%, which is based on a levered beta of 0.800. 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 Sino Biopharmaceutical
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
- Annual earnings are forecast to grow faster than the Hong Kong market.
- Trading below our estimate of fair value by more than 20%.
- Annual revenue is forecast to grow slower than the Hong Kong market.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Sino Biopharmaceutical, we've compiled three essential aspects you should assess:
- Risks: Take risks, for example - Sino Biopharmaceutical has 1 warning sign we think you should be aware of.
- Future Earnings: How does 1177'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.
- 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.
About SEHK:1177
Sino Biopharmaceutical
An investment holding company, operates as a research and development pharmaceutical conglomerate in the People’s Republic of China.
Excellent balance sheet with proven track record.