Estimating The Fair Value Of Tianda Pharmaceuticals Limited (HKG:455)

Key Insights

• The projected fair value for Tianda Pharmaceuticals is HK$0.32 based on 2 Stage Free Cash Flow to Equity
• With HK$0.26 share price, Tianda Pharmaceuticals appears to be trading close to its estimated fair value
• Industry average discount to fair value of 41% suggests Tianda Pharmaceuticals' peers are currently trading at a higher discount

Does the March share price for Tianda Pharmaceuticals Limited (HKG:455) 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 their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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

Crunching The Numbers

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. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$12.2m	HK$16.7m	HK$21.1m	HK$25.2m	HK$28.8m	HK$31.8m	HK$34.4m	HK$36.5m	HK$38.3m	HK$39.9m
Growth Rate Estimate Source	Est @ 52.43%	Est @ 37.32%	Est @ 26.73%	Est @ 19.33%	Est @ 14.14%	Est @ 10.51%	Est @ 7.97%	Est @ 6.19%	Est @ 4.95%	Est @ 4.07%
Present Value (HK$, Millions) Discounted @ 6.4%	HK$11.4	HK$14.7	HK$17.5	HK$19.7	HK$21.1	HK$21.9	HK$22.2	HK$22.2	HK$21.9	HK$21.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$194m

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 (2.0%) 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 6.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$40m× (1 + 2.0%) ÷ (6.4%– 2.0%) = HK$928m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$928m÷ ( 1 + 6.4%)¹⁰= HK$498m

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 HK$692m. 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$0.3, the company appears about fair value at a 19% 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.

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 Tianda Pharmaceuticals 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 6.4%, 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 Tianda Pharmaceuticals

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Tianda Pharmaceuticals, we've put together three essential elements you should explore:

1. Risks: For example, we've discovered 1 warning sign for Tianda Pharmaceuticals that you should be aware of before investing here.
2. 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!
3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.