Fair value estimate of Hangzhou Robam Appliances Co., Ltd. (SZSE:002508)

Key findings

• The estimated fair value of Hangzhou Robam Appliances is CN¥27.49 based on the 2-step Free Cash Flow to Equity
• The current share price of CN¥22.10 suggests that Hangzhou Robam Appliances may be trading close to its fair value
• The analyst price target of CN¥26.62 for 2508 is 3.1% below our fair value estimate

Does the share price of Hangzhou Robam Appliances Co., Ltd. (SZSE:002508) in June reflect its actual value? Today we will estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There is actually not too much to it, even though it may seem quite complex.

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 it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Hangzhou Robam Appliances

Processing the numbers

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. 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 aren’t 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.

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) = 12 billion CNY

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value, which takes into account all future cash flows 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 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 9.8%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥2.3b × (1 + 2.9%) ÷ (9.8% – 2.9%) = CN¥35b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= CN¥35b÷ ( 1 + 9.8 %)¹⁰= 14 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 CNY26 billion. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of CNY22.1, the company appears to be about fair value, at a 20% 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 that in mind.

The assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own 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 Hangzhou Robam Appliances 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 9.8%, which is based on a leveraged beta of 1.226. Beta is a measure of a stock’s volatility relative to the market as a whole. 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 Hangzhou Robam Appliances

Go on:

Valuation is only one side of the coin in building your investment thesis and just one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. A better way would be to apply different cases and assumptions and see how they would affect the company’s valuation. For example, slightly adjusting the terminal value growth rate can dramatically change the overall result. For Hangzhou Robam Appliances, we have compiled three important factors that you should examine in more detail:

1. Risks: Take risks, for example – Hangzhou Robam Appliances has 1 warning sign In our opinion, you should be aware of this.
2. Future income: How does 002508’s growth rate compare to 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 high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

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