The projected fair value for Hwatsing Technology is CN¥176 based on 2 Stage Free Cash Flow to Equity
Hwatsing Technology's CN¥130 share price signals that it might be 26% undervalued
Analyst price target for 688120 is CN¥164 which is 7.2% below our fair value estimate
Does the August share price for Hwatsing Technology Co., Ltd. (SHSE:688120) 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. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Crunching The Numbers
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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CN¥, Millions)
CN¥766.4m
CN¥1.20b
CN¥1.68b
CN¥2.18b
CN¥2.64b
CN¥3.05b
CN¥3.42b
CN¥3.73b
CN¥4.00b
CN¥4.24b
Growth Rate Estimate Source
Est @ 79.52%
Est @ 56.52%
Est @ 40.42%
Est @ 29.15%
Est @ 21.26%
Est @ 15.74%
Est @ 11.87%
Est @ 9.16%
Est @ 7.27%
Est @ 5.94%
Present Value (CN¥, Millions) Discounted @ 9.5%
CN¥700
CN¥1.0k
CN¥1.3k
CN¥1.5k
CN¥1.7k
CN¥1.8k
CN¥1.8k
CN¥1.8k
CN¥1.8k
CN¥1.7k
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥15b
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. 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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.5%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥66b÷ ( 1 + 9.5%)10= CN¥27b
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¥42b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥130, the company appears a touch undervalued at a 26% 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.
SHSE:688120 Discounted Cash Flow August 20th 2024
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Hwatsing Technology 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 9.5%, which is based on a levered beta of 1.328. 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 Hwatsing Technology
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Balance sheet summary for 688120.
Weakness
Earnings growth over the past year is below its 5-year average.
Dividend is low compared to the top 25% of dividend payers in the Semiconductor market.
What are analysts forecasting for 688120?
Opportunity
Annual earnings are forecast to grow faster than the Chinese market.
Trading below our estimate of fair value by more than 20%.
Threat
No apparent threats visible for 688120.
Moving On:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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. Can we work out why the company is trading at a discount to intrinsic value? For Hwatsing Technology, there are three relevant elements you should assess:
Risks: For example, we've discovered 1 warning sign for Hwatsing Technology that you should be aware of before investing here.
Future Earnings: How does 688120'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.
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 SHSE 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.