Estimating The Fair Value Of Sunny Optical Technology (Group) Company Limited (HKG:2382)

Key Insights

• The projected fair value for Sunny Optical Technology (Group) is HK$105 based on 2 Stage Free Cash Flow to Equity
• With HK$96.75 share price, Sunny Optical Technology (Group) appears to be trading close to its estimated fair value
• Our fair value estimate is 3.5% lower than Sunny Optical Technology (Group)'s analyst price target of CN¥109

In this article we are going to estimate the intrinsic value of Sunny Optical Technology (Group) Company Limited (HKG:2382) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for Sunny Optical Technology (Group)

The Calculation

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CN¥, Millions)	CN¥2.59b	CN¥3.99b	CN¥4.97b	CN¥6.11b	CN¥7.56b	CN¥8.64b	CN¥9.54b	CN¥10.3b	CN¥10.9b	CN¥11.4b
Growth Rate Estimate Source	Analyst x5	Analyst x8	Analyst x6	Analyst x2	Analyst x2	Est @ 14.22%	Est @ 10.48%	Est @ 7.86%	Est @ 6.02%	Est @ 4.74%
Present Value (CN¥, Millions) Discounted @ 9.7%	CN¥2.4k	CN¥3.3k	CN¥3.8k	CN¥4.2k	CN¥4.8k	CN¥5.0k	CN¥5.0k	CN¥4.9k	CN¥4.7k	CN¥4.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥43b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 9.7%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥11b× (1 + 1.7%) ÷ (9.7%– 1.7%) = CN¥146b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥146b÷ ( 1 + 9.7%)¹⁰= CN¥58b

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¥101b. 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$96.8, the company appears about fair value at a 7.8% 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

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 Sunny Optical Technology (Group) 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 1.111. 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 Sunny Optical Technology (Group)

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sunny Optical Technology (Group), we've put together three relevant elements you should further examine:

1. Risks: Case in point, we've spotted 1 warning sign for Sunny Optical Technology (Group) you should be aware of.
2. Future Earnings: How does 2382'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.