Innovent Biologics, Inc. (HKG:1801) Shares Could Be 50% Below Their Intrinsic Value Estimate

Key Insights

• Innovent Biologics' estimated fair value is CN¥65.4 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥32.7 suggests Innovent Biologics is 50% undervalued
• Analyst price target for 1801 is CN¥47.13 which is 28% below our fair value estimate

In this article we are going to estimate the intrinsic value of Innovent Biologics, Inc. (HKG:1801) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for Innovent Biologics

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	-CN¥1.62b	-CN¥644.5m	CN¥940.7m	CN¥2.07b	CN¥3.08b	CN¥4.15b	CN¥5.18b	CN¥6.11b	CN¥6.90b	CN¥7.56b
Growth Rate Estimate Source	Analyst x12	Analyst x11	Analyst x5	Analyst x5	Est @ 48.86%	Est @ 34.69%	Est @ 24.77%	Est @ 17.82%	Est @ 12.96%	Est @ 9.56%
Present Value (CN¥, Millions) Discounted @ 7.1%	-CN¥1.5k	-CN¥562	CN¥765	CN¥1.6k	CN¥2.2k	CN¥2.7k	CN¥3.2k	CN¥3.5k	CN¥3.7k	CN¥3.8k

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

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 (1.6%) 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 7.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥7.6b× (1 + 1.6%) ÷ (7.1%– 1.6%) = CN¥139b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥139b÷ ( 1 + 7.1%)¹⁰= CN¥70b

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¥89b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$32.7, the company appears quite undervalued at a 50% discount to where the stock price trades currently. 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.

The 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 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 7.1%, which is based on a levered beta of 0.850. 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

Looking Ahead:

Whilst important, the DCF calculation 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. 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. Can we work out why the company is trading at a discount to intrinsic value? For Innovent Biologics, we've put together three important aspects you should further examine:

1. Risks: You should be aware of the 1 warning sign for Innovent Biologics we've uncovered before considering an investment in the company.
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 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.