Are Investors Undervaluing ASM Pacific Technology Limited (HKG:522) By 37%?

By
Simply Wall St
Published
February 25, 2022
SEHK:522
Source: Shutterstock

Does the February share price for ASM Pacific Technology Limited (HKG:522) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing 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. 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 ASM Pacific Technology

The method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of 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, 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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (HK$, Millions) HK$3.08b HK$2.41b HK$3.31b HK$3.41b HK$3.50b HK$3.58b HK$3.65b HK$3.72b HK$3.78b HK$3.85b
Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x1 Est @ 3.1% Est @ 2.61% Est @ 2.27% Est @ 2.03% Est @ 1.87% Est @ 1.75% Est @ 1.67%
Present Value (HK$, Millions) Discounted @ 7.3% HK$2.9k HK$2.1k HK$2.7k HK$2.6k HK$2.5k HK$2.3k HK$2.2k HK$2.1k HK$2.0k HK$1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$23b

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = HK$3.8b× (1 + 1.5%) ÷ (7.3%– 1.5%) = HK$67b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= HK$67b÷ ( 1 + 7.3%)10= HK$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 HK$56b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$85.7, the company appears quite undervalued at a 37% 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.

dcf
SEHK:522 Discounted Cash Flow February 25th 2022

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 ASM Pacific Technology 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 7.3%, which is based on a levered beta of 1.201. 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.

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. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For ASM Pacific Technology, we've put together three further items you should assess:

  1. Risks: Every company has them, and we've spotted 2 warning signs for ASM Pacific Technology (of which 1 is concerning!) you should know about.
  2. Future Earnings: How does 522'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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Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.

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