Calculating The Fair Value Of CircuTech International Holdings Limited (HKG:8051)

Key Insights

• CircuTech International Holdings' estimated fair value is HK$3.46 based on 2 Stage Free Cash Flow to Equity
• CircuTech International Holdings' HK$3.43 share price indicates it is trading at similar levels as its fair value estimate
• Peers of CircuTech International Holdings are currently trading on average at a 350% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of CircuTech International Holdings Limited (HKG:8051) as an investment opportunity by projecting its future cash flows and then discounting them to today's 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!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for CircuTech International Holdings

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$5.62m	HK$5.93m	HK$6.20m	HK$6.42m	HK$6.62m	HK$6.79m	HK$6.96m	HK$7.11m	HK$7.25m	HK$7.40m
Growth Rate Estimate Source	Est @ 7.24%	Est @ 5.59%	Est @ 4.44%	Est @ 3.63%	Est @ 3.06%	Est @ 2.66%	Est @ 2.39%	Est @ 2.19%	Est @ 2.06%	Est @ 1.96%
Present Value (HK$, Millions) Discounted @ 9.4%	HK$5.1	HK$5.0	HK$4.7	HK$4.5	HK$4.2	HK$4.0	HK$3.7	HK$3.5	HK$3.2	HK$3.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$41m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (1.7%) 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 9.4%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$7.4m× (1 + 1.7%) ÷ (9.4%– 1.7%) = HK$98m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$98m÷ ( 1 + 9.4%)¹⁰= HK$40m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK$81m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of HK$3.4, the company appears about fair value at a 0.9% 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

Now 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 CircuTech International 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 9.4%, which is based on a levered beta of 1.097. 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.

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For CircuTech International Holdings, we've compiled three important items you should further research:

1. Risks: For instance, we've identified 1 warning sign for CircuTech International Holdings that you should be aware of.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

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.

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.