Yangtze Optical Fibre And Cable Joint Stock Limited Company's (HKG:6869) Intrinsic Value Is Potentially 62% Above Its Share Price

Key Insights

• Yangtze Optical Fibre And Cable Limited's estimated fair value is HK$77.72 based on 2 Stage Free Cash Flow to Equity
• Yangtze Optical Fibre And Cable Limited is estimated to be 38% undervalued based on current share price of HK$48.00
• Analyst price target for 6869 is CN¥20.67 which is 73% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Yangtze Optical Fibre And Cable Joint Stock Limited Company (HKG:6869) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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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. 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.

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

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥714.0m	CN¥1.52b	CN¥2.10b	CN¥2.68b	CN¥3.21b	CN¥3.68b	CN¥4.10b	CN¥4.45b	CN¥4.75b	CN¥5.02b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 37.97%	Est @ 27.39%	Est @ 19.98%	Est @ 14.79%	Est @ 11.16%	Est @ 8.62%	Est @ 6.84%	Est @ 5.60%
Present Value (CN¥, Millions) Discounted @ 8.9%	CN¥656	CN¥1.3k	CN¥1.6k	CN¥1.9k	CN¥2.1k	CN¥2.2k	CN¥2.3k	CN¥2.2k	CN¥2.2k	CN¥2.1k

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

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 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥5.0b× (1 + 2.7%) ÷ (8.9%– 2.7%) = CN¥83b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥83b÷ ( 1 + 8.9%)¹⁰= CN¥35b

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¥54b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$48.0, the company appears quite good value at a 38% 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 Yangtze Optical Fibre And Cable Limited 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 8.9%, which is based on a levered beta of 1.185. 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.

Check out our latest analysis for Yangtze Optical Fibre And Cable Limited

SWOT Analysis for Yangtze Optical Fibre And Cable Limited

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Yangtze Optical Fibre And Cable Limited, we've put together three relevant items you should look at:

1. Risks: Take risks, for example - Yangtze Optical Fibre And Cable Limited has 2 warning signs (and 1 which is concerning) we think you should know about.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for 6869's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.