A look at the intrinsic value of Shanghai Fudan Microelectronics Group Company Limited (HKG: 1385)

How far is Shanghai Fudan Microelectronics Group Company Limited (HKG:1385) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

See our latest analysis for Shanghai Fudan Microelectronics Group

The calculation

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, so 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (CN¥, Million) CN¥758.0m CN¥1.08b CN¥1.33b CN¥1.55b CN¥1.73b CN¥1.88b CN¥2.01b CN¥2.11b CN¥2.20b CN¥2.27b
Growth rate estimate Source Analyst x1 Analyst x1 East @ 22.92% Is at 16.51% Is at 12.02% Is at 8.88% Is at 6.68% East @ 5.14% Is at 4.06% East @ 3.31%
Present value (CN¥, million) discounted at 7.4% CN¥706 CN¥936 CN¥1.1k CN¥1.2k CN¥1.2k CN¥1.2k CN¥1.2k CN¥1.2k CN¥1.2k CN¥1.1k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥11b

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.4%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥2.3b × (1 + 1.6%) ÷ (7.4%–1.6%) = CN¥40b

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥40b÷ ( 1 + 7.4%)ten= CN¥20b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 31 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$36.0, the company appears to be about fair value at a 13% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.

SEHK: 1385 Cash Flow Update September 25, 2022

Important assumptions

Now, the most important 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 entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Shanghai Fudan Microelectronics Group 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 7.4%, which is based on a leveraged beta of 1.176. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Shanghai Fudan Microelectronics Group, there are three fundamental aspects that you should consider in more detail:

  1. Risks: We believe that you should evaluate the 1 warning sign for Shanghai Fudan Microelectronics Group we reported before investing in the company.
  2. Future earnings: How does the growth rate of 1385 compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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