A look at the fair value of Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874)

Key findings

• The estimated fair value of Guangzhou Baiyunshan Pharmaceutical Holdings is HK$19.10 based on 2-step free cash flow to equity
• With a share price of HK$20.80, Guangzhou Baiyunshan Pharmaceutical Holdings appears to be trading close to its estimated fair value
• The analyst price target for 874 is CN¥25.85, which is 35% above our fair value estimate.

Does the Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) share price in July reflect its actual value? Today we will estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to today’s value using the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many and is not without its flaws. For those who enjoy stock analysis, the Simply Wall St analysis model presented here might be of interest.

View our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings

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 may have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to get estimates of the next ten years of cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last 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.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present 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) = 11 billion CNY

The second period is also called the terminal value. This is the company’s cash flow after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year Treasury yield (2.2%) 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 6.7%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥1.5b × (1 + 2.2%) ÷ (6.7% – 2.2%) = CN¥34b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥34b÷ ( 1 + 6.7 %)¹⁰= 18 billion CNY

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is CN¥29 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of HK$20.8, the company appears to be about its fair value at the time of writing. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

The assumptions

The key 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 repeating the calculations yourself and playing around with them. 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 Guangzhou Baiyunshan Pharmaceutical Holdings as prospective 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 6.7%, which is based on a leveraged beta of 0.800. 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 Guangzhou Baiyunshan Pharmaceutical Holdings

Go on:

While a company’s valuation is important, ideally it shouldn’t be the only analysis you look at for a company. It’s not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” If a company grows at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome may look very different. For Guangzhou Baiyunshan Pharmaceutical Holdings, we’ve compiled three other aspects to consider:

1. Risks: Take risks, for example – Guangzhou Baiyunshan Pharmaceutical Holdings has 1 warning sign In our opinion, you should be aware of this.
2. Future income: How does 874’s growth rate compare to its peers 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 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 you might be missing out on!

PS. The Simply Wall St app runs a discounted cash flow valuation for every stock on the SEHK 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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