A Look At The Intrinsic Value Of Shanghai Junshi Biosciences Co., Ltd. (HKG:1877)

Key Insights

• Shanghai Junshi Biosciences' estimated fair value is CN¥54.3 based on 2 Stage Free Cash Flow to Equity
• Current share price of CN¥44.2 suggests Shanghai Junshi Biosciences is trading close to its fair value
• Analyst price target for 1877 is CN¥52.81 which is 2.8% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Shanghai Junshi Biosciences Co., Ltd. (HKG:1877) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Shanghai Junshi Biosciences

The Model

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	-CN¥1.47b	-CN¥118.6m	CN¥186.4m	CN¥1.44b	CN¥2.09b	CN¥2.59b	CN¥3.05b	CN¥3.44b	CN¥3.76b	CN¥4.02b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Analyst x1	Analyst x1	Est @ 24.26%	Est @ 17.47%	Est @ 12.72%	Est @ 9.39%	Est @ 7.06%
Present Value (CN¥, Millions) Discounted @ 7.3%	-CN¥1.4k	-CN¥103	CN¥151	CN¥1.1k	CN¥1.5k	CN¥1.7k	CN¥1.9k	CN¥2.0k	CN¥2.0k	CN¥2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥11b

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 7.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥4.0b× (1 + 1.6%) ÷ (7.3%– 1.6%) = CN¥72b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥72b÷ ( 1 + 7.3%)¹⁰= CN¥35b

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¥46b. 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$44.2, the company appears about fair value at a 19% 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.

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. 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 Shanghai Junshi Biosciences 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 7.3%, which is based on a levered beta of 0.815. 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 Shanghai Junshi Biosciences

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. For Shanghai Junshi Biosciences, we've compiled three relevant aspects you should look at:

1. Risks: Every company has them, and we've spotted 2 warning signs for Shanghai Junshi Biosciences (of which 1 is a bit unpleasant!) you should know about.
2. Future Earnings: How does 1877'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. 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.