Is Shanghai Junshi Biosciences Co., Ltd. (HKG:1877) Trading At A 38% Discount?

Key Insights

• The projected fair value for Shanghai Junshi Biosciences is HK$35.20 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$21.65 suggests Shanghai Junshi Biosciences is potentially 38% undervalued
• The CN¥33.52 analyst price target for 1877 is 4.8% less than our estimate of fair value

Does the November share price for Shanghai Junshi Biosciences Co., Ltd. (HKG:1877) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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. 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 Shanghai Junshi Biosciences

Is Shanghai Junshi Biosciences Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 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¥1.60b	-CN¥1.05b	CN¥597.0m	CN¥980.0m	CN¥1.29b	CN¥1.59b	CN¥1.85b	CN¥2.08b	CN¥2.27b	CN¥2.43b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Analyst x1	Est @ 31.89%	Est @ 22.91%	Est @ 16.63%	Est @ 12.23%	Est @ 9.15%	Est @ 7.00%
Present Value (CN¥, Millions) Discounted @ 6.8%	-CN¥1.5k	-CN¥924	CN¥490	CN¥753	CN¥929	CN¥1.1k	CN¥1.2k	CN¥1.2k	CN¥1.3k	CN¥1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.7b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥2.4b× (1 + 2.0%) ÷ (6.8%– 2.0%) = CN¥51b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥51b÷ ( 1 + 6.8%)¹⁰= CN¥26b

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¥32b. 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$21.7, the company appears quite good value at a 38% 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 6.8%, 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 Shanghai Junshi Biosciences

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Shanghai Junshi Biosciences, we've compiled three essential items you should assess:

1. Risks: Be aware that Shanghai Junshi Biosciences is showing 2 warning signs in our investment analysis , 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 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. 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.