An Intrinsic Calculation For Sichuan Kelun-Biotech Biopharmaceutical Co., Ltd. (HKG:6990) Suggests It's 45% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Sichuan Kelun-Biotech Biopharmaceutical fair value estimate is HK$193
• Current share price of HK$107 suggests Sichuan Kelun-Biotech Biopharmaceutical is potentially 45% undervalued
• Analyst price target for 6990 is CN¥121 which is 37% below our fair value estimate

Does the January share price for Sichuan Kelun-Biotech Biopharmaceutical Co., Ltd. (HKG:6990) 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

View our latest analysis for Sichuan Kelun-Biotech Biopharmaceutical

The Model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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¥830.7m	-CN¥425.0m	-CN¥274.7m	CN¥300.5m	CN¥770.6m	CN¥1.21b	CN¥1.70b	CN¥2.19b	CN¥2.65b	CN¥3.05b
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x2	Analyst x4	Analyst x4	Est @ 57.01%	Est @ 40.50%	Est @ 28.94%	Est @ 20.85%	Est @ 15.19%
Present Value (CN¥, Millions) Discounted @ 6.8%	-CN¥778	-CN¥372	-CN¥225	CN¥231	CN¥554	CN¥814	CN¥1.1k	CN¥1.3k	CN¥1.5k	CN¥1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥5.6b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥3.1b× (1 + 2.0%) ÷ (6.8%– 2.0%) = CN¥64b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥64b÷ ( 1 + 6.8%)¹⁰= CN¥33b

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¥39b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$107, the company appears quite undervalued at a 45% 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

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. 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 Sichuan Kelun-Biotech Biopharmaceutical 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 Sichuan Kelun-Biotech Biopharmaceutical

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. 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 Sichuan Kelun-Biotech Biopharmaceutical, we've put together three relevant items you should further research:

1. Risks: For instance, we've identified 1 warning sign for Sichuan Kelun-Biotech Biopharmaceutical that you should be aware of.
2. Future Earnings: How does 6990'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. 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.