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A Look At The Fair Value Of Shenzhen Salubris Pharmaceuticals Co., Ltd. (SZSE:002294)

Simply Wall St ·  May 22 00:13

Key Insights

  • Shenzhen Salubris Pharmaceuticals' estimated fair value is CN¥30.19 based on 2 Stage Free Cash Flow to Equity
  • Shenzhen Salubris Pharmaceuticals' CN¥28.70 share price indicates it is trading at similar levels as its fair value estimate
  • Our fair value estimate is 18% lower than Shenzhen Salubris Pharmaceuticals' analyst price target of CN¥37.00

Today we will run through one way of estimating the intrinsic value of Shenzhen Salubris Pharmaceuticals Co., Ltd. (SZSE:002294) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over 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 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 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¥578.6m CN¥736.1m CN¥760.5m CN¥1.40b CN¥1.58b CN¥1.71b CN¥1.83b CN¥1.93b CN¥2.02b CN¥2.11b
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 8.42% Est @ 6.76% Est @ 5.61% Est @ 4.79% Est @ 4.23%
Present Value (CN¥, Millions) Discounted @ 7.4% CN¥539 CN¥638 CN¥614 CN¥1.1k CN¥1.1k CN¥1.1k CN¥1.1k CN¥1.1k CN¥1.1k CN¥1.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥9.4b

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 (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 7.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥2.1b× (1 + 2.9%) ÷ (7.4%– 2.9%) = CN¥48b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥48b÷ ( 1 + 7.4%)10= CN¥24b

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¥33b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥28.7, the company appears about fair value at a 4.9% 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.

dcf
SZSE:002294 Discounted Cash Flow May 22nd 2024

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Shenzhen Salubris Pharmaceuticals 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 7.4%, 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 Shenzhen Salubris Pharmaceuticals

Strength
  • Debt is not viewed as a risk.
  • Balance sheet summary for 002294.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Pharmaceuticals market.
Opportunity
  • Annual revenue is forecast to grow faster than the Chinese market.
  • Current share price is below our estimate of fair value.
Threat
  • Dividends are not covered by earnings and cashflows.
  • Annual earnings are forecast to grow slower than the Chinese market.
  • See 002294's dividend history.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. For Shenzhen Salubris Pharmaceuticals, we've compiled three additional factors you should consider:

  1. Risks: For instance, we've identified 1 warning sign for Shenzhen Salubris Pharmaceuticals that you should be aware of.
  2. Future Earnings: How does 002294'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.
  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 is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock 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.

Disclaimer: This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any specific investment or investment strategy. Read more
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