Zhejiang HangKe Technology's estimated fair value is CN¥22.81 based on 2 Stage Free Cash Flow to Equity
With CN¥20.82 share price, Zhejiang HangKe Technology appears to be trading close to its estimated fair value
Our fair value estimate is 17% higher than Zhejiang HangKe Technology's analyst price target of CN¥19.54
Today we will run through one way of estimating the intrinsic value of Zhejiang HangKe Technology Incorporated Company (SHSE:688006) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.
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.
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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (CN¥, Millions)
CN¥299.0m
CN¥443.0m
CN¥557.5m
CN¥663.1m
CN¥756.5m
CN¥837.5m
CN¥907.4m
CN¥967.9m
CN¥1.02b
CN¥1.07b
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ 25.85%
Est @ 18.94%
Est @ 14.09%
Est @ 10.71%
Est @ 8.33%
Est @ 6.67%
Est @ 5.51%
Est @ 4.70%
Present Value (CN¥, Millions) Discounted @ 8.2%
CN¥276
CN¥378
CN¥440
CN¥483
CN¥509
CN¥521
CN¥521
CN¥514
CN¥501
CN¥484
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥4.6b
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 (2.8%) 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 8.2%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥20b÷ ( 1 + 8.2%)10= CN¥9.1b
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¥14b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥20.8, the company appears about fair value at a 8.7% 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.
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 Zhejiang HangKe 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 8.2%, which is based on a levered beta of 1.093. 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 Zhejiang HangKe Technology
Strength
Debt is well covered by earnings.
Dividend is in the top 25% of dividend payers in the market.
Dividend information for 688006.
Weakness
Earnings declined over the past year.
Opportunity
Annual earnings are forecast to grow faster than the Chinese market.
Good value based on P/E ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Paying a dividend but company has no free cash flows.
Is 688006 well equipped to handle threats?
Next Steps:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. For Zhejiang HangKe Technology, we've compiled three essential aspects you should consider:
Risks: For instance, we've identified 4 warning signs for Zhejiang HangKe Technology (1 shouldn't be ignored) you should be aware of.
Future Earnings: How does 688006'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.