Stock Analysis

Estimating The Intrinsic Value Of Hansoh Pharmaceutical Group Company Limited (HKG:3692)

SEHK:3692
Source: Shutterstock

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Hansoh Pharmaceutical Group fair value estimate is HK$20.26
  • Hansoh Pharmaceutical Group's HK$17.20 share price indicates it is trading at similar levels as its fair value estimate
  • Our fair value estimate is 5.0% higher than Hansoh Pharmaceutical Group's analyst price target of CN¥19.29

Does the May share price for Hansoh Pharmaceutical Group Company Limited (HKG:3692) 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. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

View our latest analysis for Hansoh Pharmaceutical Group

Step By Step Through The Calculation

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 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.

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) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (CN¥, Millions) CN¥3.54b CN¥3.91b CN¥4.19b CN¥4.73b CN¥5.15b CN¥5.47b CN¥5.74b CN¥5.97b CN¥6.18b CN¥6.38b
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x6 Analyst x4 Analyst x4 Est @ 6.15% Est @ 4.95% Est @ 4.11% Est @ 3.52% Est @ 3.11%
Present Value (CN¥, Millions) Discounted @ 6.7% CN¥3.3k CN¥3.4k CN¥3.5k CN¥3.7k CN¥3.7k CN¥3.7k CN¥3.7k CN¥3.6k CN¥3.5k CN¥3.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥35b

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 (2.2%) 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¥6.4b× (1 + 2.2%) ÷ (6.7%– 2.2%) = CN¥145b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥145b÷ ( 1 + 6.7%)10= CN¥76b

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¥111b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$17.2, the company appears about fair value at a 15% 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.

dcf
SEHK:3692 Discounted Cash Flow May 23rd 2024

The 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 Hansoh Pharmaceutical Group 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 Hansoh Pharmaceutical Group

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
Opportunity
  • Annual revenue is forecast to grow faster than the Hong Kong market.
  • Current share price is below our estimate of fair value.
Threat
  • Annual earnings are forecast to grow slower than the Hong Kong market.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Hansoh Pharmaceutical Group, we've compiled three relevant aspects you should consider:

  1. Financial Health: Does 3692 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does 3692'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.

Valuation is complex, but we're helping make it simple.

Find out whether Hansoh Pharmaceutical Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.