Key Insights
The projected fair value for China Feihe is HK$7.25 based on 2 Stage Free Cash Flow to Equity
Current share price of HK$4.54 suggests China Feihe is potentially 37% undervalued
Our fair value estimate is 9.3% higher than China Feihe's analyst price target of CN¥6.63
Today we will run through one way of estimating the intrinsic value of China Feihe Limited (HKG:6186) by taking the expected future cash flows and discounting them to today's 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.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for China Feihe
Is China Feihe Fairly Valued?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. 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 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.
A DCF is all about the idea that a dollar in the future is less valuable 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) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (CN¥, Millions) | CN¥5.17b | CN¥5.46b | CN¥4.26b | CN¥3.68b | CN¥3.39b | CN¥3.22b | CN¥3.12b | CN¥3.07b | CN¥3.06b | CN¥3.07b |
Growth Rate Estimate Source | Analyst x5 | Analyst x5 | Analyst x1 | Analyst x1 | Est @ -7.99% | Est @ -5.03% | Est @ -2.96% | Est @ -1.51% | Est @ -0.49% | Est @ 0.22% |
Present Value (CN¥, Millions) Discounted @ 6.7% | CN¥4.8k | CN¥4.8k | CN¥3.5k | CN¥2.8k | CN¥2.4k | CN¥2.2k | CN¥2.0k | CN¥1.8k | CN¥1.7k | CN¥1.6k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥28b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) 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 6.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥3.1b× (1 + 1.9%) ÷ (6.7%– 1.9%) = CN¥64b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥64b÷ ( 1 + 6.7%)10= CN¥34b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is CN¥61b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$4.5, the company appears quite good value at a 37% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
SEHK:6186 Discounted Cash Flow August 16th 2023
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 China Feihe 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 6.7%, which is based on a levered beta of 0.800. 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 China Feihe
Strength
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend information for 6186.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Food market.
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 Hong Kong market.
What else are analysts forecasting for 6186?
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For China Feihe, we've compiled three essential aspects you should explore:
Risks: To that end, you should be aware of the 1 warning sign we've spotted with China Feihe .
Future Earnings: How does 6186'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 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 is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.