BYD Electronic (International) Company Limited's (HKG:285) Intrinsic Value Is Potentially 32% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, BYD Electronic (International) fair value estimate is HK$31.43
• BYD Electronic (International)'s HK$23.80 share price signals that it might be 24% undervalued
• The CN¥27.59 analyst price target for 285 is 12% less than our estimate of fair value

Does the June share price for BYD Electronic (International) Company Limited (HKG:285) 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 their present value. This will be done using the Discounted Cash Flow (DCF) model. 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. 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 BYD Electronic (International)

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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¥577.0m	CN¥2.31b	CN¥3.32b	CN¥4.10b	CN¥4.80b	CN¥5.40b	CN¥5.90b	CN¥6.32b	CN¥6.66b	CN¥6.95b
Growth Rate Estimate Source	Analyst x6	Analyst x7	Analyst x7	Est @ 23.58%	Est @ 17.05%	Est @ 12.47%	Est @ 9.27%	Est @ 7.03%	Est @ 5.46%	Est @ 4.36%
Present Value (CN¥, Millions) Discounted @ 9.2%	-CN¥529	CN¥1.9k	CN¥2.6k	CN¥2.9k	CN¥3.1k	CN¥3.2k	CN¥3.2k	CN¥3.1k	CN¥3.0k	CN¥2.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥25b

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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CN¥7.0b× (1 + 1.8%) ÷ (9.2%– 1.8%) = CN¥96b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥96b÷ ( 1 + 9.2%)¹⁰= CN¥40b

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¥65b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$23.8, the company appears a touch undervalued at a 24% 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.

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 BYD Electronic (International) 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 9.2%, which is based on a levered beta of 1.031. 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 BYD Electronic (International)

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For BYD Electronic (International), we've put together three additional aspects you should consider:

1. Risks: You should be aware of the 1 warning sign for BYD Electronic (International) we've uncovered before considering an investment in the company.
2. Future Earnings: How does 285'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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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.