An Intrinsic Calculation For AAC Technologies Holdings Inc. (HKG:2018) Suggests It's 44% Undervalued

Key Insights

• AAC Technologies Holdings' estimated fair value is HK$34.18 based on 2 Stage Free Cash Flow to Equity
• AAC Technologies Holdings is estimated to be 44% undervalued based on current share price of HK$19.08
• Analyst price target for 2018 is CN¥19.96 which is 42% below our fair value estimate

In this article we are going to estimate the intrinsic value of AAC Technologies Holdings Inc. (HKG:2018) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for AAC Technologies Holdings

Is AAC Technologies Holdings Fairly Valued?

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 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥2.51b	CN¥2.81b	CN¥2.94b	CN¥3.04b	CN¥3.13b	CN¥3.21b	CN¥3.30b	CN¥3.37b	CN¥3.45b	CN¥3.53b
Growth Rate Estimate Source	Analyst x5	Analyst x6	Analyst x1	Est @ 3.45%	Est @ 3.03%	Est @ 2.73%	Est @ 2.52%	Est @ 2.38%	Est @ 2.28%	Est @ 2.21%
Present Value (CN¥, Millions) Discounted @ 9.7%	CN¥2.3k	CN¥2.3k	CN¥2.2k	CN¥2.1k	CN¥2.0k	CN¥1.8k	CN¥1.7k	CN¥1.6k	CN¥1.5k	CN¥1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥19b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 9.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥3.5b× (1 + 2.0%) ÷ (9.7%– 2.0%) = CN¥47b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥47b÷ ( 1 + 9.7%)¹⁰= CN¥19b

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¥38b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$19.1, the company appears quite good value at a 44% 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.

Important 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 AAC Technologies Holdings 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 9.7%, which is based on a levered beta of 1.358. 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 AAC Technologies Holdings

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For AAC Technologies Holdings, we've compiled three essential aspects you should explore:

1. Risks: As an example, we've found 1 warning sign for AAC Technologies Holdings that you need to consider before investing here.
2. Future Earnings: How does 2018'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.