Are Investors Undervaluing Hangzhou SF Intra-city Industrial Co., Ltd. (HKG:9699) By 30%?

Key Insights

• The projected fair value for Hangzhou SF Intra-city Industrial is HK$14.75 based on 2 Stage Free Cash Flow to Equity
• Current share price of HK$10.26 suggests Hangzhou SF Intra-city Industrial is potentially 30% undervalued
• Our fair value estimate is 24% higher than Hangzhou SF Intra-city Industrial's analyst price target of CN¥11.93

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hangzhou SF Intra-city Industrial Co., Ltd. (HKG:9699) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 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 Hangzhou SF Intra-city Industrial

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 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥49.5m	CN¥158.6m	CN¥266.7m	CN¥395.5m	CN¥531.6m	CN¥662.8m	CN¥781.2m	CN¥883.5m	CN¥969.8m	CN¥1.04b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 68.17%	Est @ 48.31%	Est @ 34.41%	Est @ 24.68%	Est @ 17.87%	Est @ 13.10%	Est @ 9.76%	Est @ 7.42%
Present Value (CN¥, Millions) Discounted @ 7.6%	CN¥46.0	CN¥137	CN¥214	CN¥295	CN¥369	CN¥427	CN¥468	CN¥492	CN¥501	CN¥501

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.4b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥1.0b× (1 + 2.0%) ÷ (7.6%– 2.0%) = CN¥19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥19b÷ ( 1 + 7.6%)¹⁰= CN¥9.1b

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¥13b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$10.3, the company appears quite good value at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Hangzhou SF Intra-city Industrial 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 7.6%, which is based on a levered beta of 0.928. 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.

Moving On:

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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Hangzhou SF Intra-city Industrial, we've compiled three essential factors you should look at:

1. Risks: You should be aware of the 1 warning sign for Hangzhou SF Intra-city Industrial we've uncovered before considering an investment in the company.
2. Future Earnings: How does 9699'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.

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.