Sunny Optical Technology (Group) Company Limited (HKG:2382) Shares Could Be 29% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Sunny Optical Technology (Group) is HK$105 based on 2 Stage Free Cash Flow to Equity
• Sunny Optical Technology (Group) is estimated to be 29% undervalued based on current share price of HK$74.45
• The CN¥105 analyst price target for 2382is comparable to our estimate of fair value.

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sunny Optical Technology (Group) Company Limited (HKG:2382) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Sunny Optical Technology (Group)

Step By Step Through The Calculation

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¥3.65b	CN¥4.79b	CN¥6.11b	CN¥7.56b	CN¥8.64b	CN¥9.54b	CN¥10.3b	CN¥10.9b	CN¥11.4b	CN¥11.9b
Growth Rate Estimate Source	Analyst x8	Analyst x7	Analyst x2	Analyst x2	Est @ 14.24%	Est @ 10.51%	Est @ 7.90%	Est @ 6.07%	Est @ 4.79%	Est @ 3.89%
Present Value (CN¥, Millions) Discounted @ 9.9%	CN¥3.3k	CN¥4.0k	CN¥4.6k	CN¥5.2k	CN¥5.4k	CN¥5.4k	CN¥5.3k	CN¥5.1k	CN¥4.9k	CN¥4.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥48b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥12b× (1 + 1.8%) ÷ (9.9%– 1.8%) = CN¥149b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥149b÷ ( 1 + 9.9%)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¥106b. 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$74.5, the company appears a touch undervalued at a 29% 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.

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 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 9.9%, which is based on a levered beta of 1.134. 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)

Next Steps:

Although the valuation of a company is important, 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Sunny Optical Technology (Group), there are three fundamental items you should assess:

1. Risks: Take risks, for example - Sunny Optical Technology (Group) has 1 warning sign we think 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. 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.