An Intrinsic Calculation For Innovent Biologics, Inc. (HKG:1801) Suggests It's 34% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Innovent Biologics fair value estimate is HK$57.76
• Innovent Biologics is estimated to be 34% undervalued based on current share price of HK$38.30
• Analyst price target for 1801 is CN¥51.07 which is 12% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Innovent Biologics, Inc. (HKG:1801) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Innovent Biologics

The Method

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 begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	-CN¥820.0m	CN¥264.3m	CN¥1.59b	CN¥2.50b	CN¥3.23b	CN¥3.91b	CN¥4.51b	CN¥5.02b	CN¥5.44b	CN¥5.79b
Growth Rate Estimate Source	Analyst x12	Analyst x8	Analyst x6	Analyst x6	Est @ 29.19%	Est @ 21.00%	Est @ 15.26%	Est @ 11.25%	Est @ 8.44%	Est @ 6.47%
Present Value (CN¥, Millions) Discounted @ 6.7%	-CN¥768	CN¥232	CN¥1.3k	CN¥1.9k	CN¥2.3k	CN¥2.6k	CN¥2.9k	CN¥3.0k	CN¥3.0k	CN¥3.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥20b

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. 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 (1.9%) 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 6.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥5.8b× (1 + 1.9%) ÷ (6.7%– 1.9%) = CN¥122b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥122b÷ ( 1 + 6.7%)¹⁰= CN¥63b

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¥83b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$38.3, the company appears quite undervalued at a 34% 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.

The 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 Innovent Biologics 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 6.7%, 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 Innovent Biologics

Next Steps:

Although the valuation of a company is important, 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Innovent Biologics, we've put together three further aspects you should assess:

1. Risks: Be aware that Innovent Biologics is showing 1 warning sign in our investment analysis , you should know about...
2. Future Earnings: How does 1801'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.