Are Investors Undervaluing RemeGen Co., Ltd. (HKG:9995) By 36%?

Key Insights

• RemeGen's estimated fair value is HK$75.09 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$48.40 suggests RemeGen is potentially 36% undervalued
• Analyst price target for 9995 is CN¥71.75 which is 4.4% below our fair value estimate

Does the March share price for RemeGen Co., Ltd. (HKG:9995) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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 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 RemeGen

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.

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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	-CN¥819.3m	-CN¥413.7m	CN¥368.8m	CN¥927.6m	CN¥1.47b	CN¥1.90b	CN¥2.31b	CN¥2.66b	CN¥2.97b	CN¥3.22b
Growth Rate Estimate Source	Analyst x11	Analyst x11	Analyst x5	Analyst x5	Analyst x5	Est @ 29.63%	Est @ 21.26%	Est @ 15.40%	Est @ 11.31%	Est @ 8.44%
Present Value (CN¥, Millions) Discounted @ 7.5%	-CN¥762	-CN¥358	CN¥297	CN¥695	CN¥1.0k	CN¥1.2k	CN¥1.4k	CN¥1.5k	CN¥1.6k	CN¥1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥8.1b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥3.2b× (1 + 1.7%) ÷ (7.5%– 1.7%) = CN¥57b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥57b÷ ( 1 + 7.5%)¹⁰= CN¥28b

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¥36b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$48.4, the company appears quite undervalued at a 36% 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.

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 RemeGen 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 7.5%, 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 RemeGen

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. 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. What is the reason for the share price sitting below the intrinsic value? For RemeGen, there are three additional aspects you should explore:

1. Risks: Take risks, for example - RemeGen has 1 warning sign we think you should be aware of.
2. Future Earnings: How does 9995'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.