Are investors undervaluing 3Peak Incorporated (SHSE:688536) by 39%?

Key findings

• The forecast fair value for 3Peak is CN¥148 based on the 2-step Free Cash Flow to Equity
• The current share price of 90.22 CNY suggests that 3Peak may be undervalued by 39%
• The analyst price target for 688536 is CN¥114, which is 23% below our fair value estimate.

Today we will go through one way to estimate the intrinsic value of 3Peak Incorporated (SHSE:688536) by projecting future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are relatively easy to follow.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you want to learn more about intrinsic value, you should take a look at Simply Wall St’s analysis model.

Check out our latest analysis for 3Peak

Step by step through the calculation

We use the two-stage growth model, which simply means that we consider two stages of the company’s growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 7.1 billion CNY

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.9%) 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 10%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥2.4b × (1 + 2.9%) ÷ (10% – 2.9%) = CN¥33b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥33b÷ ( 1 + 10 %)¹⁰= 13 billion CNY

The total value or equity value is then the sum of the present value of future cash flows, which in this case is CNY20 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CNY90.2, the company seems to offer quite good value for money at a 39% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider 3Peak 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 takes debt into account. In this calculation, we used 10%, which is based on a leveraged beta of 1.311. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for 3Peak

Go on:

While a company’s valuation is important, ideally it shouldn’t be the only analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. What is the reason for the stock price being below the intrinsic value? For 3Peak, we have compiled three key points for you to consider:

1. Risks: Take risks, for example – 3Peak has 2 warning signs In our opinion, you should be aware of this.
2. Future income: How does the growth rate of 688536 compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for each Chinese stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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