The projected fair value for De Rucci Healthy Sleep is CN¥55.78 based on 2 Stage Free Cash Flow to Equity
De Rucci Healthy Sleep's CN¥34.55 share price signals that it might be 38% undervalued
Our fair value estimate is 36% higher than De Rucci Healthy Sleep's analyst price target of CN¥41.00
Today we will run through one way of estimating the intrinsic value of De Rucci Healthy Sleep Co., Ltd. (SZSE:001323) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF (CN¥, Millions)
CN¥1.19b
CN¥1.35b
CN¥1.49b
CN¥1.61b
CN¥1.71b
CN¥1.80b
CN¥1.89b
CN¥1.97b
CN¥2.04b
CN¥2.11b
Growth Rate Estimate Source
Est @ 17.71%
Est @ 13.28%
Est @ 10.18%
Est @ 8.01%
Est @ 6.49%
Est @ 5.42%
Est @ 4.68%
Est @ 4.16%
Est @ 3.79%
Est @ 3.54%
Present Value (CN¥, Millions) Discounted @ 9.9%
CN¥1.1k
CN¥1.1k
CN¥1.1k
CN¥1.1k
CN¥1.1k
CN¥1.0k
CN¥975
CN¥925
CN¥873
CN¥823
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = CN¥10b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.9%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥31b÷ ( 1 + 9.9%)10= CN¥12b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥22b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CN¥34.6, the company appears quite good value at a 38% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at De Rucci Healthy Sleep 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 accounts for debt. In this calculation we've used 9.9%, which is based on a levered beta of 1.233. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for De Rucci Healthy Sleep
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Balance sheet summary for 001323.
Weakness
No major weaknesses identified for 001323.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Threat
Annual earnings are forecast to grow slower than the Chinese market.
What else are analysts forecasting for 001323?
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For De Rucci Healthy Sleep, we've put together three important factors you should assess:
Financial Health: Does 001323 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does 001323's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts 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.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com. This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.