An Intrinsic Calculation For Nongfu Spring Co., Ltd. (HKG:9633) Suggests It's 28% Undervalued

Key Insights

• The projected fair value for Nongfu Spring is HK$44.72 based on 2 Stage Free Cash Flow to Equity
• Nongfu Spring's HK$32.05 share price signals that it might be 28% undervalued
• Analyst price target for 9633 is CN¥33.71 which is 25% below our fair value estimate

Does the November share price for Nongfu Spring Co., Ltd. (HKG:9633) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then 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.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Nongfu Spring

Step By Step Through 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. 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥14.8b	CN¥16.5b	CN¥17.8b	CN¥19.0b	CN¥19.9b	CN¥20.8b	CN¥21.5b	CN¥22.2b	CN¥22.9b	CN¥23.5b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Est @ 7.94%	Est @ 6.26%	Est @ 5.08%	Est @ 4.26%	Est @ 3.68%	Est @ 3.28%	Est @ 3.00%	Est @ 2.80%
Present Value (CN¥, Millions) Discounted @ 6.3%	CN¥13.9k	CN¥14.6k	CN¥14.8k	CN¥14.8k	CN¥14.7k	CN¥14.4k	CN¥14.0k	CN¥13.6k	CN¥13.2k	CN¥12.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥141b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥24b× (1 + 2.3%) ÷ (6.3%– 2.3%) = CN¥605b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥605b÷ ( 1 + 6.3%)¹⁰= CN¥328b

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¥468b. 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$32.1, the company appears a touch undervalued at a 28% 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 Nongfu Spring 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 6.3%, 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 Nongfu Spring

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 Nongfu Spring, we've compiled three important aspects you should further examine:

1. Risks: For example, we've discovered 1 warning sign for Nongfu Spring that you should be aware of before investing here.
2. Future Earnings: How does 9633'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 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 SEHK every day. If you want to find the calculation for other stocks 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.