The intrinsic value of Anhui Huaheng Biotechnology Co., Ltd. (SHSE:688639) may be 43% above the share price

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of Anhui Huaheng Biotechnology is CN¥95.33
• The current share price of 66.87 CNY suggests that Anhui Huaheng Biotechnology may be undervalued by 30%
• Our fair value estimate is 30% below Anhui Huaheng Biotechnology’s analyst price target of CN¥136.

How far is Anhui Huaheng Biotechnology Co., Ltd. (SHSE:688639) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by estimating the company’s future cash flows and discounting them to their current value. One way to do this is by applying the Discounted Cash Flow (DCF) model. Don’t be put off by the technical jargon, the math behind it is actually quite simple.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. For those who enjoy stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for Anhui Huaheng Biotechnology

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. In the first stage, we need to estimate the company’s cash flows for the next ten years. 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 down more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less 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) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 5.4 billion CNY

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.9%. We discount the terminal cash flows to today’s value at a cost of equity of 8.6%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.2b × (1 + 2.9%) ÷ (8.6% – 2.9%) = CN¥22b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥22b÷ ( 1 + 8.6 %)¹⁰= 9.6 billion CNY

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is CNY15 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CNY66.9, the company appears somewhat undervalued at a 30% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this as a rough estimate that is not accurate to the last cent.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider Anhui Huaheng Biotechnology 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 8.6%, which is based on a levered beta of 1.006. 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 a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Anhui Huaheng Biotechnology

Looking ahead:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. 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, adjusting the terminal value growth rate slightly can change the overall result dramatically. Can we figure out why the company is trading at a discount to intrinsic value? For Anhui Huaheng Biotechnology, we have compiled three other elements for you to investigate further:

1. Risks: Consider, for example, the ever-present specter of investment risk. We have identified 3 warning signs with Anhui Huaheng Biotechnology (at least two of which are significant), and understanding them should be part of your investment process.
2. Future income: How does the growth rate of 688639 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. The Simply Wall St app runs 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.

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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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