Is BOE Technology Group Company Limited (SZSE:000725) Trading At A 43% Discount?

Key Insights

• BOE Technology Group's estimated fair value is CN¥7.40 based on 2 Stage Free Cash Flow to Equity
• BOE Technology Group's CN¥4.25 share price signals that it might be 43% undervalued
• The CN¥5.24 analyst price target for 000725 is 29% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of BOE Technology Group Company Limited (SZSE:000725) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for BOE Technology Group

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 begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥21.9b	CN¥25.8b	CN¥25.0b	CN¥24.7b	CN¥24.8b	CN¥25.0b	CN¥25.4b	CN¥25.8b	CN¥26.4b	CN¥27.0b
Growth Rate Estimate Source	Analyst x2	Analyst x1	Est @ -2.81%	Est @ -1.11%	Est @ 0.08%	Est @ 0.91%	Est @ 1.49%	Est @ 1.90%	Est @ 2.18%	Est @ 2.38%
Present Value (CN¥, Millions) Discounted @ 11%	CN¥19.7k	CN¥21.0k	CN¥18.4k	CN¥16.4k	CN¥14.9k	CN¥13.5k	CN¥12.4k	CN¥11.4k	CN¥10.5k	CN¥9.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥148b

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 11%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥27b× (1 + 2.9%) ÷ (11%– 2.9%) = CN¥352b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥352b÷ ( 1 + 11%)¹⁰= CN¥127b

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¥275b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of CN¥4.3, the company appears quite undervalued at a 43% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

We would point out that 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 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 BOE Technology 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 accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 1.588. 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 BOE Technology Group

Moving On:

Whilst important, the DCF calculation 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For BOE Technology Group, we've put together three further factors you should consider:

1. Risks: As an example, we've found 2 warning signs for BOE Technology Group that you need to consider before investing here.
2. Future Earnings: How does 000725'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.

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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.