A Look At The Intrinsic Value Of HUYA Inc. (NYSE:HUYA)

Key Insights

• The projected fair value for HUYA is US$3.74 based on 2 Stage Free Cash Flow to Equity
• HUYA's US$3.11 share price indicates it is trading at similar levels as its fair value estimate
• The CN¥4.57 analyst price target for HUYA is 22% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of HUYA Inc. (NYSE:HUYA) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for HUYA

Crunching The Numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥529.9m	CN¥651.3m	CN¥429.8m	CN¥405.2m	CN¥392.1m	CN¥386.3m	CN¥385.3m	CN¥387.7m	CN¥392.4m	CN¥398.8m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x1	Est @ -5.74%	Est @ -3.23%	Est @ -1.48%	Est @ -0.25%	Est @ 0.61%	Est @ 1.21%	Est @ 1.64%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥489	CN¥555	CN¥338	CN¥294	CN¥263	CN¥239	CN¥220	CN¥205	CN¥191	CN¥179

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.0b

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 (2.6%) 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 8.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥399m× (1 + 2.6%) ÷ (8.3%– 2.6%) = CN¥7.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥7.2b÷ ( 1 + 8.3%)¹⁰= CN¥3.2b

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¥6.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$3.1, the company appears about fair value at a 17% 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

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. 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 HUYA 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 8.3%, which is based on a levered beta of 1.145. 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.

Looking Ahead:

Although the valuation of a company is important, 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. 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 HUYA, there are three fundamental elements you should assess:

1. Risks: Be aware that HUYA is showing 1 warning sign in our investment analysis , you should know about...
2. Future Earnings: How does HUYA'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 NYSE 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.